US government debt under pressure as traders await Fed minutes

A US government debt downturn deepened on Wednesday and stock markets fell, after a top Federal Reserve official signalled a rapid reversal of the central bank’s ultra-loose pandemic-era policies.

The yield on the benchmark 10-year US Treasury note, which moves inversely to its price and underpins borrowing costs worldwide, added 0.07 percentage points to 2.62 per cent, a level not seen since early 2019.

The yield on the policy-sensitive two-year note rose 0.06 percentage points to 2.57 per cent, sitting just below that of the longer-dated debt instrument. This part of the so-called yield curve inverted last month for the first time since 2019, in what economists typically view as an indication of a looming recession.

In equities, the Stoxx Europe 600 dropped 1 per cent in morning trades and London’s FTSE 100 lost 0.6 per cent, following falls in Asia earlier in the day. Futures trading implied the S&P 500 would edge 0.4 per cent lower in early New York dealings.

Fed governor Lael Brainard on Tuesday said a “rapid” reduction of the US central bank’s balance sheet could start in May. The balance sheet had swelled to $9tn since the Fed announced unlimited bond purchases in March 2020, which lowered Treasury yields and in turn reduced loan rates.

With US consumer price inflation running at a 40-year high and potential further sanctions on Russian energy resources threatening to cause more spikes, analysts also expect the Fed to raise interest rates aggressively this year. Minutes from the Fed’s March policy meeting, to be released later on Wednesday, are expected to offer clues as to how swiftly this process will occur.

“By removing these asset purchases and selling bonds that are on the balance sheet,” said Juliette Cohen, strategist at CPR Asset Management, “it says we don’t need so much [monetary] accommodation due to the high level of inflation, and reinforces the idea they will be hiking interest rates.”

Equity markets have been less vulnerable to inflation and Russia’s invasion of Ukraine, analysts said, because the real yield on the 10-year Treasury note — the return investors earn after inflation — is below zero, making equity returns potentially more attractive.

“With cash/bonds still offering negative real yields, investors have been inclined to buy the dips in global equities,” Citi strategists, led by Robert Buckland, wrote in a research note. They cautioned, however, to “expect US real yields to go positive in 2023, which may prove more challenging.”

The Stoxx is trading above its closing level of February 23, the eve of president Vladimir Putin’s invasion of Ukraine. Wall Street’s benchmark S&P 500 index is about 7 per cent higher.

In Asia, Hong Kong’s Hang Seng index dropped 1.9 per cent as Chinese bourses reopened after a holiday. Japan’s Nikkei 225 fell 1.6 per cent.

China’s service sector suffered its worst contraction last month since February 2020 at the outset of the coronavirus pandemic, according to a private sector survey.

The Caixin services purchasing managers’ index, which asks companies in the sector whether they experienced an increase or decrease in business activity compared with the previous month, came in at 42.0 on Wednesday, well below the 50-point threshold that separates contraction from expansion.

China is battling its worst outbreak of coronavirus since the pandemic began, with strict lockdowns in multiple cities, including the commercial centre Shanghai.