Surging US Breakeven Rates Signal Upward Pressure on Yields Amidst Fed's Inflation Struggle

Surging US Breakeven Rates Signal Upward Pressure on Yields Amidst Fed's Inflation Struggle 

The US two-year breakeven rate is surging, indicating a significant increase that will push bond yields higher.

Inflation expectations are on the rise, suggesting that the Federal Reserve's efforts to combat inflation are faltering. Torsten Slok, Chief Economist at Apollo Management, warns that a strengthening US economy, combined with underlying inflationary pressures, will likely prevent the Federal Reserve from lowering interest rates in 2024.

The data paints a picture of the Fed's struggle against inflation, which is far from being resolved. Core PCE (Personal Consumption Expenditures) is at its highest level in nearly a year, while both CPI (Consumer Price Index) and PPI (Producer Price Index) have exceeded expectations.

This trend is occurring as breakeven rates and yields are increasingly moving in tandem, indicating that breakeven rates are exerting more influence on yields. The correlation between two-year breakeven rates and two-year yields is strengthening, as shown in the chart below.

Bloomberg's Correlation Finder reveals that two-year breakeven rates are closely tracking five- and ten-year yields, suggesting that rising inflation expectations could lift yields across different maturity periods.

Although Treasury yields are currently declining, this situation tests the theory presented. Nonetheless, it's crucial to remain mindful of these risks. Historically, significant rises in breakeven rates have preceded substantial market losses, as evidenced by the Bloomberg US Treasury Total Return Index's sharp 12% decline in 2022 – the largest drop since 1974, a year marked by President Nixon's resignation.