Gertrude Chavez–Dreyfuss, Karen Brettell

(Reuters] – The perfect storm is brewing for U.S. Treasuries. Investors are worried about a Federal Reserve becoming more hawkish and a surge in inflation.

On Thursday, benchmark 10-year yields jumped to 1.753% from 1.491% at the year-end and 1.353% Dec. 20, respectively. Now, yields have fallen to 1.776% in March 2021 which is the highest level since February 2020.

Analysts believe that a break through technical resistance of around 1.79% will signal additional gains towards the 2% zone.

In the latter half 2021, there were several rally in benchmark yields, which move inversely with bond prices. These rallies occurred as market worries about COVID-19, economic expansion, and investors seeking out U.S. government debt because of its higher yields.

Investors are increasingly assuming that this is a different time, due to the fact that a Fed of hawkish looks ready to take on inflation.

Yields took an extra leg higher after minutes from the Fed’s December meeting released on Wednesday showed that officials had discussed shrinking the U.S. central bank’s overall asset holdings as well as raising interest rates sooner than expected to fight inflation.

“This talk about letting the balance sheet runoff and envisaging a future where there are no more Fed purchases… people are going to prepare for that now,” said Tom Simons, a money market economist at Jefferies.

Another factor that can push yields lower is corporate debt issuers locking rates in a rush to beat rate rises and broad market repricing bonds following safe-haven demands.

The ratio between demand and supply of bonds is expected to increase this year, as central banks cut back on purchases. Only two months back, the Fed purchased an extra $120 billion a month of bonds.

HAWKISH FEED

Due to surging inflation pressures, the Fed will have to reduce its exceptional accommodation. Inflation could be impacted by the rapid spread of Omicron coronavirus, which may cause supply disruptions and increase inflation pressure.

A surprisingly strong ADP National Employment Report Wednesday suggests that labor market recovery could justify increasing rates. On Friday, the U.S. government is expected to release their highly anticipated December jobs report.

“It looks like the conditions for Fed rate hikes have pretty much been met with the labor market now pretty robust,” said Kim Rupert, managing director in global fixed income analysis at Action Economics, though she noted that holiday-season could have created data anomalies.

Fed funds futures fully price in three rate rises before 2022 ends, the first likely occurring as early as March.

SUPPLY DEMAND BALANCE

The rush of corporates to get into the bond market before the Fed increases rates causes Treasury weakness. This is because issuers agree to lock the rates during sales.

Companies are looking to get as much debt as they can. There will be more conversations about issuing debt as soon rates go up, rather than waiting for it to improve,” Tom di Galoma (a managing director at Seaport Global Holdings) in New York said.

Global bond demand and supply will be worsening this year, as central banks including the Fed (ECB) and European Central Banks (Fed) reduce their bond buying. This may increase upward pressure on yields.

Nikolaos Panigirtzoglou and other JPMorgan analysts stated Wednesday in a JPMorgan report that if Fed balance sheets begin to shrink after two September hikes then the market could need $150 billion in additional Treasury issuances over the fourth quarter of 2022.

New spending legislation, the Build back Better Act, could be passed by Congress to increase net issuance to $200 billion. That’s $250 billion of spending new and $50 billion for taxes.

JPMorgan predicts a $1.1 trillion decrease in global bond demand and supply this year relative 2021. This could lead to a drop in yields at Bloomberg Barclays Global Aggregate index rises by 30 basis point (LON: