MacroscopeAs the US Federal Reserve tops up the punch bowl, it must remember that the bond market can still intimidate

US bond markets are historically wary of policymakers who appear complacent about inflation risks

When there is fear of future price inflation in the air, markets expect to be compensated appropriately and reprice accordingly

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Federal Reserve chair Jerome Powell believes it “may take more than three years” to hit the 2 per cent average inflation target. Photo: Reuters

Published: 1:31am, 3 Mar 2021Updated: 3:08am, 3 Mar 2021

Falling prices in the US government bond market last week saw the yield on the benchmark 10-year US Treasury rise to 1.61 per cent on Thursday, its highest level for 12 months. US Treasuries subsequently regained some poise, but the US bond market is edgy. Fears of future inflation have gathered pace and are not misplaced.

Lower US Treasury prices, occasioning higher yields, may have further to run. Along with the absolute necessity of ensuring a successful vaccine roll-out, US policymakers are deploying massive fiscal stimulus combined with ultra-accommodative monetary policy settings to maximise the chances of US economic recovery from the Covid-19 pandemic.

Such monetary accommodation is consistent with suppressed Treasury yields but the US bond market understands fully that the more successful the policy mix is, the greater the US economic resurgence and the greater the likelihood that yields will need to rise.

As higher yields are a direct consequence of lower US Treasury prices, why would any investor hold onto such US paper today if the perception is that the market as a whole expects the price of that paper to be lower tomorrow? From a capital preservation perspective, it’s far better to sell today.

That scenario won’t appeal to US policymakers who see continuing low Treasury yields as an integral part of the campaign to re-energise the economy, but they may have to get used to it. When there is fear of future price inflation in the air, markets expect to be compensated appropriately and re-price accordingly.

A woman carries shopping bags in New York on December 10, 2020. US policymakers see continuing low Treasury yields as an integral part of the campaign to re-energise the economy. Photo: AP

But there’s an added problem in that Federal Reserve chief Jerome Powell and his colleagues don’t seem to share the US bond market’s concerns about inflation, choosing instead to emphasise the continuing fragility of the economy, highlighting the millions of US jobs lost during the pandemic.