Inflation expectations affect Treasuries
The week ending June 20, saw investors getting wary of investing in Treasury securities over inflation expectations. An inflation-led increase in interest rates makes the fixed coupon on Treasury bonds less attractive and reduces investor demand for these securities. The drop in the prices of bonds led to a rise in the yield curve.
A stronger than expected CPI inflation rate
The week saw the release of the Consumer Price Index (or CPI) estimates for the month of May by the Bureau of Labor Statistics, U.S. Department of Labor on Tuesday, June 17.
According to the release, consumer price inflation was stronger than expected in May, driven by energy and food prices particularly. Overall consumer price inflation posted at 0.4% compared to 0.3% in the month of April, and market expectations of 0.2% for the month of May. May was the largest increase since August, 2011.Consequently, bond prices decreased because of investor concerns over inflation, causing the Treasury yield curve to rise along the long end.
Investors are now eyeing key economic indicator releases scheduled for next week including the gross domestic product (or GDP), durable goods, home sales, personal consumption expenditure index (or PCE), and consumer spending.
Change in the market interest rates are based on the economic environment, inflation expectations, Federal Reserve policy, and simple forces of supply and demand. The interest rates in the long-term Treasury securities are impacted by changing market interest rates as more cash flows get affected due to higher duration. Investor concerns over a rise in interest rates due to inflation, especially in case of longer-duration bonds which are affected more, sent yields up as prices dropped, steepening the Treasury yield curve at the long end.
Popular exchange-traded funds (or ETFs) like the iShares Barclays 1–3 Year Treasury Bond Fund (SHY) and the iShares Barclays 20 Year Treasury Bond Fund (TLT), track the performance of short-term and long-term U.S. Treasury securities, respectively. With Treasury securities highly sensitive to changes in the Fed funds rate and inflation expectations, investors may want to de-risk or hedge by investing in ETFs like the ProShares Short 20+ Year Treasury (TBF). Besides Treasuries, ETFs like the ProShares Investment Grade-Interest Rate Hedged ETF (IGHG), which has its major holdings in companies like Citigroup Inc. (C) and JP Morgan Chase & Co. (JPM), also protect against interest rate risk.
The next parts of this series will analyze the demand (as indicated by the bid-to-cover ratio) for securities auctioned in the past week.