Inflation worries seep back into US bond market

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A closely watched bond market indicator is pointing to rising price pressures in the US, in anticipation of policies from president-elect Donald Trump that are seen as likely to fuel inflation.

So-called break-evens on US sovereign debt — a proxy for investors’ inflation expectations — have risen steadily in recent weeks, prompted by economic data pointing to stickier than expected price pressures and Trump’s rising electoral chances.

The two-year break-even — the gap between yields on Treasury bonds and inflation-linked bonds, showing the average inflation needed for them to provide the same return — has moved up by one percentage point since September to 2.6 per cent.

The rate moved up as markets more broadly began to price in a potential Trump presidency, and then jumped following his emphatic win this week.

Traders have been betting that Trump’s plans for tariffs and tax cuts will provide what Barclays analysts have called a “reflationary cocktail” for the world’s biggest economy.

“We don’t just look for a very shortlived overshoot on inflation [due to Trump’s policies], this could be more structural and protracted,” said Mark Dowding, chief investment officer at RBC BlueBay Asset Management.

Bond giant Pimco has also warned about the impact of “reflationary” policies.

However, other investors have questioned whether market expectations of inflation have been overdone, if Trump’s campaign rhetoric on tariffs and taxes is not matched by his actions in office.

Federal Reserve chair Jay Powell indicated on Thursday that he was not yet concerned about the shift in inflation expectations, saying they were broadly consistent with its 2 per cent inflation target.

Break-evens have also moved higher in the UK, as investors readjust to the likely inflationary effects of Labour’s first Budget. Two-year break-evens — which are structurally higher than in the US as they reflect an older inflation measure — have ticked higher from 2.9 per cent in mid-September to 3.1 per cent, and slightly more for longer-term inflation expectations.

Investors will now be assessing whether the impact on inflation from US and UK government policies will be enough to change significantly the easing path for central banks.

RBC’s Dowding said factors pushing up inflation, including a rise in employment costs from the Budget, could be an “impediment to the Bank of England lowering interest rates much further”, after its quarter-point cut this week.

On Thursday, BoE governor Andrew Bailey said the central bank would take “a gradual approach” to future cuts as it waits to see how price pressures develop. The minutes of the monetary policy committee highlighted “upside risks to goods and commodity prices from greater trade fragmentation”, without mentioning Trump.