Long-dated U.S. Treasury yields retreated Thursday as Federal Reserve Chairman Powell said that a recent bout of high inflation has left the central bank “not comfortable” but undaunted in the belief that inflation, even though well above the levels consistent with the central bank’s objectives of a 2% annual rate, would eventually recede.

How Treasurys are performing
  • The 10-year Treasury note yields
    TMUBMUSD10Y,
    1.296%

    1.297%, versus 1.356% at 3 p.m. Eastern Time.

  • The 30-year Treasury bond rate
    TMUBMUSD30Y,
    1.917%

    was at 1.916%, compared with 1.989% a day ago.

  • The 2-year Treasury note
    TMUBMUSD02Y,
    0.229%

    was yielding 0.225%, barely changed from Wednesday’s rate.

Fixed-income drivers

Powell, in an appearance before the Senate Banking Committee, repeated his message from the previous day when he testified before a House panel, telling lawmakers that inflation has risen significantly and would likely remain high for a few months before moderating.

He admitted however the surge in inflation has surprised policy makers.

“This is a shock going through the system associated with reopening of the economy, and it has driven inflation well above 2%. And of course we’re not comfortable with that,” Powell told Senate lawmakers in the second, and final, day of semiannual congressional testimony.

Treasury buyers are shaking off inflation fears to buy bonds, with some professionals pointing to ample liquidity helping to underpin appetite for Treasurys.

Perhaps stoking that appetite is the belief, articulated by Powell in his testimony in front of a House panel on Wednesday, that the labor market is “a ways off” from where it needs to be to warrant an end to monthly purchases of $80 billion of Treasurys and $40 billion of mortgage-backed securities that had helped to support financial markets and the economy since the start of the COVID pandemic last year.

“Conditions in the labor market have continued to improve, but there is still a long way to go,” Powell told a House Financial Services Committee on Wednesday, emphasizing that he viewed pricing pressures to be the result of short-term factors, including supply-chain bottlenecks, base effects, or comparisons with prices that had fallen sharply in 2020 and a surge in demand as the economy reopens.

The 10-year Treasury drifted to an intraday low yield around 1.293% and the 2-year and 10-year yield curve, or differential between short-dated government debt and its longer-dated counterpart was at 1.075 percentage points, according to FactSet.

A flattening yield curve means borrowers pay less of a premium than previously to borrow over a longer period and suggests investors fear that economic growth may be peaking.

Meanwhile, Chicago Fed President Charles Evans said in a webcast that the central bank will get a clearer idea on the path of inflation by the end of the year. Like other top Fed officials, he’s blamed the recent spike in the cost of living on the reopening of the economy and the resulting shortages of supplies and labor.

In other economic data, the Philadelphia Fed’s factory index fell to 21.9 in June from 30.7 in prior month. Separately, the New York Fed’s Empire State Index jumped 25.6 points to a record-high reading of 43 in July. Economists had expected a reading of 17.3, according to a survey by The Wall Street Journal. Any reading above zero for either index indicates improving conditions.

U.S. industrial production rose 0.4% in June, the Federal Reserve reported Thursday, but a shortage of semiconductors contributed to a 6.6% drop in production of motor vehicles and parts. Excluding autos, industrial output rose 0.8% in the month.

Outside of the U.S., China’s economic growth slowed to still-strong 7.9% over a year earlier in the three months ending in June as a rebound from the coronavirus pandemic leveled off.

Separately, the U.S. Treasury Department called for large position reports from holders of 10-year notes due November 2030 that exceeded $4.1 billion.

What strategists and traders say

“The recent decline in Treasury yields reflects an overly pessimistic economic outlook. Strong economic growth, elevated inflation, increased global vaccination rates and the less dovish FOMC should lift the 10-year yield back toward 1.90% in Q4,” wrote John Canavan, lead analyst at Oxford Economics in a Thursday research note.



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