Yields on longer dated US Treasuries have been steadily climbing in recent weeks. Fears of earlier than expected rate rises, a tapering of asset purchases by central banks coupled with a strong rebound in economic activity were the main factors driving the bond yields. In the chart, the 10-year US breakeven inflation rate, which is a key gauge of the market’s annual inflation expectations over the next decade, rose to 2.31% on 19 March, the highest since May 2013.
The Fed’s latest reiteration of its accommodative policy stance appears to have eased some concerns. But the fact that the Fed chairman had indicated the central bank was comfortable with the current level of yields fuelled expectations that policymakers will allow inflation to overshoot and triggered more bearish bets on the long end of the Treasury curve.
According to Eastspring’s Asian Fixed Income team, the concerns over higher inflation remain premature and the recent moves have been excessive; further rises are likely to be capped. Although reflation trades have gained pace lately, inflation has remained modest in most major economies. Moreover, secular disinflationary trends and the still significant global output gap are expected to keep inflationary pressures in check.
Nevertheless, some rate volatility in the near term is to be expected as market participants continue to challenge the Fed on the timing of its first rate hike. The team remains optimistic about the outlook for Asian bonds. With liquidity conditions remaining flush, the yield advantage offered by Asian bonds as well as the stronger growth backdrop should continue to appeal to investors. They have an overweight call on Asian high yield corporates; their higher carry and room for spread compression could provide the buffer against the near-term upward pressure on US rates.