Treasury yields at new highs as balance sheet rundown talk weighs

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LONDON — Selling gripped the U.S. Treasury market on Wednesday, pushing yields to multi-year highs as traders braced for the Federal Reserve to cut its bond holdings and deliver aggressive interest rate hikes to tame inflation in coming months.

A day after remarks from Fed officials on balance sheet reduction triggered a new selloff, attention turned to minutes from the March Fed meeting, due at 1800 GMT.

The minutes may add detail to policymakers’ thinking about how quickly they could move to reduce bondholdings and lift rates.

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U.S. borrowing costs rose sharply during the Asian session and remained higher in London trade.

Two-year Treasury yields were last up around 5 basis points on the day at 2.57%, having hit 2.60%, the highest since January 2019.

Five-year yields rose to around 2.79%, the highest since December 2018, and benchmark 10-year yields climbed as much as 6.6 bps to a three-year high of 2.633%.

The 10-year yield is now up more than 22 bps since Friday and is back above the 2-year yield. It has surged over 100 bps this year.

The gap between 2 and 10-year bond yields was at almost 5 basis points. This closely-watched part of the U.S. yield curve, viewed as a good indicator of recession risk, had been inverted for much of the past week.

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Remarks from Fed Governor Lael Brainard, flagging rapid reductions to the Fed’s balance sheet beginning as soon as May, triggered the latest bout of selling.

Brainard said she expected a combination of rate rises and a rapid balance sheet runoff to take U.S. monetary policy to a “more neutral position” later this year.

“Brainard didn’t say anything extremely hawkish, but mentioning that policy would get to neutral and that bringing down inflation is the Fed’s most important task, as opposed to a balanced unemployment and inflation focus, is strong enough of a change in stance,” said NatWest Markets strategist Jan Nevruzi.

Headline U.S. inflation is running at a 40-year high at almost 8% and recent weeks have seen Fed officials ramp up their hawkish rhetoric.

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Randy Kroszner, a former Fed Governor and now an economics professor at the University of Chicago Booth School of Business, said the Fed was right to act now while longer-term inflation expectations remained anchored.

“Given that we’ve had significant 8% inflation and it’s likely to persist for quite some time, longer-term inflation expectations have not yet become unanchored,” he said.

“So, they (Fed policymakers) have the opportunity to maintain credibility, but they need to act boldly and that means rapid rate increases, that means a more rapid winding down of the balance sheet than they would have wanted to do.”

(Reporting by Dhara Ranasinghe in London and Tom Westbrook in Singapore; editing by Kim Coghill)