Fed Chair Powell Faces Taper Test as Inflation Bets Pile Up, Yields Rise

A key market gauge of inflation expectations hit a fresh 2013 high Wednesday ahead of a crucial Fed decision that could signal the long march towards normalizing interest rates.
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U.S. Treasury bond yields moved higher Wednesday, taking benchmark 10-year notes firmly past 1.6%, amid a jump in market-based inflation gauges ahead of a crucial Federal Reserve policy meeting later in the session.

The so-called breakeven rate between ten-year Treasury bonds and ten-year inflation protected securities, a key market gauge for consumer price increases, rose to 2.425% in early Wednesday trading, the highest level since 2013.  

Benchmark 10-year note yields, meanwhile, eased from a two-week high of 1.652% in early trading to change hands at 1.63%, but still look relatively well-offered in a market that has grown increasingly sensitive to inflation risks.

That might not be enough to induce a change of heart from Fed chairman Jerome Powell, who has insisted that price pressures will be 'transitory' and vowed to keep interest rates -- and the $120 billion pace of monthly bond purchases --- in place until there is what he describes as "substantial further progress" is evident in both the labor market and inflation trends.

On the former, the movement is clear: last month, more than 916,000 new jobs were added to the economy as states re-opened amid an accelerated vaccine rollout, while weekly claims for unemployment benefits are slowing sharply.

However, 8.5 million Americans haven't been re-hired since last year's pandemic-induced layoffs, and the Fed doesn't expect to see full employment until at least 2023.

"Powell is under no real pressure to shift his stance yet, given that core CPI inflation in March was only 1.6%, with the core PCE measure in February --  the latest reading -- at 1.4%," said Ian Shepherdson of Pantheon Macroeconomics. "Adverse base effects will push inflation higher for a time, and we're expecting margin rebounds in COVID-hit sectors to lift it further over the summer, but this hasn't happened yet."

"Right now, though, Mr. Powell will continue to emphasize that employment remains far below its pre-COVID level—we estimate that payrolls are almost 12 million lower than would have been likely if COVID hadn't happened—arguing that it makes little sense to be worrying about inflation risks while the labor market is so slack," he added.

On inflation, however, trends are indeed moving in a singular direction: The Conference Board's April consumer confidence index surged to 132.6 points, the highest reading in a year, as Americans look into the final months of the coronavirus pandemic with renewed optimism, while inflation expectations were pegged at 6.7%.

U.S. consumer price inflation increased at the fastest pace in eight-and-half years last month, in fact, amid the accelerating re-opening of the domestic economy.

Comparable figures for the months of April through July, which will reflect changes from the peak of last year's coronavirus pandemic, are expected to show a notable acceleration of inflation measures that investors are concerned will last for a longer period than Fed officials, who have consistently said the impact will be temporary.

Bank of America, which has been tracking data from U.S. earnings conference calls since 2004, noted earlier this week that references to "inflation" have tripled from last year amid decade-high prices for commodities such as copper and palladium and a massive surge in global oil prices from last year's pandemic-induced plunge as well corn and soybeans.

The Fed will release its main policy statement at 2:00 PM Eastern time, with Powell taking questions from reporters thirty minutes later.