Oct 3 (Reuters) - The soundest gauges of the bond market's long-term inflation view plunged last week to their lowest in almost two years, suggesting investors think the Fed will get inflation back near its target level as it hikes rates and slows the economy.
The five- and 10-year Breakeven Inflation rates , which reflect the difference in yields of U.S. Treasury Inflation Protected Securities (TIPS) and U.S. Treasury notes, fell to their lowest since February 2021, when inflation expectations were subdued as the economy recovered from the pandemic shut downs and the Federal Reserve was downplaying the risk of runaway inflation.
Gennadiy Goldberg, senior rates strategist at TD Securities, New York, said specialist funds appeared to be behind some of the selling in TIPS, which raised the real yields of these securities relative to the nominal yields of Treasuries.
Friday's low for the five-year BEI was 2.125%, implying a view that inflation will average just over 2 percent over the next five years. It was last around 2.25%. The Fed has been tightening interest rates aggressively since March to control runaway inflation and bring it down to its target of 2%.
"The market is confident in the Fed’s ability," said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania. "Even though you see short-term interest rates going up quite a bit, that tighter policy has a dampening impact on inflation going forward. But also a piece of it was just risk assets selling off."
Heightened risk sensitivity has come as major central banks hike rates and bond markets in Britain and Europe react to their own inflation and growth problems and, in the case of the UK, announce ill-received fiscal remedies.
Bond markets in major economies have recently seen almost unprecedented illiquidity and volatility, and this may have exacerbated moves in the many corners of fixed income, including BEIs.
The 10-year BEI fell to about 2.115 on Friday and ticked back up to 2.23% on Monday. A week the 10-year BEI was toying with 2.5%.
On Thursday the 10-year BEI fell 14 basis points, its steepest drop since March 2020 when the COVID-19 virus was sending markets into a tailspin.
"You have also seen outflows from mutual funds devoted to inflation protected products," Goldberg said. "That may be behind some of these moves lower in breakevens, as a lot of investors start to exit a very popular position that was built up over last year or so." (Additional reporting by Chuck Mikolajczak; Editing by David Gregorio)
