Fixed-income drivers

Treasury yields were mostly steady as U.S. stocks extended their rally.

Fixed-income markets saw relatively muted moves as St. Louis Fed President James Bullard on Thursday warned that inflation may be stronger than Federal Reserve officials had anticipated, gaining momentum in the fall as the economic reopening from COVID expands.

“Inflation may surprise still further to the upside as the reopening process continues, beyond the level necessary to simply make up for past misses to the low side,” Bullard said, speaking at the Clayton Chamber of Commerce.

Earlier this week, Atlanta Fed President Raphael Bostic and Bullard, pointed to the possibility of a late-2022 rate increase and markets are now pricing in the first interest rate rise for February 2023, compared with December 2022, in the wake of last week’s Fed meeting.

On Wednesday, Bostic and Fed Gov. Michelle Bowman, in a separate remarks, also said that inflation may be more longer-lasting than anticipated, even if it proves to be temporary.

Bostic suggested that it might be appropriate to lift interest rates and scale back asset purchases, known as quantitative easing, in the next three or four months, at which time he sees the labor market meeting the Fed’s criteria of “substantial progress.”

Meanwhile, President Biden, on Thursday afternoon, agreed to a roughly, $1 trillion bipartisan infrastructure plan, securing a long-sought bipartisan deal on overhauling the nation’s transportation, water and broadband infrastructure that lawmakers.

“We had a really good meeting and to answer the direct question, we have a deal,” Biden told reporters at a news conference. “We’ve all agreed that none of us got what we all would have wanted,” he said.

Increases in government spending can put pressure on bonds and drive yield higher, as investors anticipate fresh issuance to fund plans.

On the economic front, investors digested a glut of U.S. data early Thursday, including first-time applications for unemployment benefits in the week ended June 19, which dipped by 7,000 to 411,000 after an upward revision to prior numbers. Economists had expected the number of initial claims to fall to 380,000 from 412,000 in the previous week.

A final reading of first-quarter gross domestic product came in at an unrevised 6.4% annual rate, while U.S. durable-goods orders climbed 2.3% in May, but core capital goods orders slipped 0.1% on the month.

Meanwhile, a reading on U.S. advanced trade deficit in goods widened to $88.1 billion in May from $85.7 in the prior month.

On the auction front, a sale of $62 billion of 7-year notes TMUBMUSD07Y, 1.237% was seen attracting strong bids. The auction stopped 0.3 bps short of the “when issued” bid as it stopped at 1.264%, signifying a solid auction, compared with previous auctions stopping within in the range of 4 basis points range.

A stop-through indicates when the highest yield the Treasury sold in the auction is below the highest yield expected when the auction began—the “when issued” level.

What strategists are saying

“We see the discussion within the Fed this way short-term: certainly Powell made his pivot last week: let’s retire the phrase ‘talking about, talking about tapering.’ So, we know we are talking about tapering and the issue now is 1) timing 2) in what sequence (Treasuries v mortgages) and speed,” Greg Faranello, head of U.S. rates at AmeriVet, wrote in a Thursday research note.

“We certainly have context going back to the last crisis but with no assurance it will look the same. This week: Powell and Williams have both expressed patience,” he said.

“As the [Federal Open Market Committee] discusses the economic conditions for tapering its asset purchases, the history of prior tapering attempts suggests the Committee will be most eager to reduce MBS purchases first,” wrote Mizuho economists Steven Ricchiuto and Alex Pelle, in a Thursday note.

“However, with evidence of minimal sector-specific financial distortions and a housing market that has passed peak activity, will the Fed want the housing market to continue to aid the current expansion or risk it becoming a drag as it did in the prior recovery?”