U.S. Treasuries Sold Off with Rising Breakeven Inflation in January

This article is reprinted from the Indexology blog of S&P Dow Jones Indices.

The year 2021 started with a continuous sell-off in the U.S. Treasury bond market. Starting on the second trading day of the year, yield on the 10-year U.S. Treasury Bond rose for five consecutive trading days by 23 bps until Jan. 12, 2021, when strong auction results for the 10-year note pulled the yield back from its high. In the second half of January, Treasuries’ yield continued to trade lower before it ticked up by the end of the month and found itself in a new range safely above 1%. The yield uptick happened toward the end of the month amid the comments of possible further ECB rate cuts, reassurance of no bond taper for “some time” by the U.S. Fed chairman, and equity market volatility.

From Aug. 4, 2020, to the end of January 2021, the 10-year U.S. Treasury yield rose 56 bps, accompanied by a steadily rising breakeven inflation rate and steepening yield curve. The 10-Year Breakeven Inflation Rate rose by 53 bps over the same period. (This rate reflects the market’s inflation expectation and is calculated as the yield difference between the 10-year U.S. treasury note and Treasury Inflation-Protected Securities [TIPS]). Real yields on TIPS across the curve are trading in negative territory. On Jan. 21, the 10-year TIPS new-issuance auction drew yield at -0.987%, only 13 bps higher than Jan. 4’s record low. The 2s10s yield curve steepened by 56 bps since last August, to the steepest level since 2018.

The Breakeven Inflation Rate rebounded strongly from the pandemic-induced low in March 2020. However, to put it into historical context, the 10-Year Breakeven Inflation, at 2.10% as of the end of January, is 9 bps above the 20-year average and 17 bps above the 10-year average. In comparison, economists are forecasting 2.1% for 2021 inflation, according to a January survey conducted by Bloomberg. The latest inflation data, released on Jan. 13, showed a small increase, to 1.4% year-over-year.

Possible factors contributing to higher market-based inflation may be a weak U.S. dollar, market expectation of more economic stimulus, hopes of an improved economic outlook following the start of the COVID-19 vaccine rollout, and the Fed’s signal of willingness to keep inflation running higher than the 2% target before hiking rates. On the other hand, inflation skeptics may point to the slack in the labor market and in the output gap. It remains to be seen if loose monetary policy and expansive fiscal spending will push inflation up or not, but inflation concerns will likely remain in investors’ minds in 2021.

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