As we write March is shaping up to be the worst month for US government debt (Treasuries) since 2016. Downward pressure on prices recently pushed the 10-year Treasury yield as high as 2.5%.

This marks not far off a full percentage point increase since the beginning of 2022.

Bond prices and yields move in opposite directions, falling prices mean higher yields, while rising prices mean lower yields.

When the 10-year yield goes up, so do mortgage rates and other borrowing rates. It also impacts the rate at which companies can borrow.

This may reduce their ability to engage in projects that foster growth and innovation and maintain generous dividends to shareholders.

WHY IS IT HAPPENING?

There are two inter-related reasons that explain the recent surge in Treasury yields. First, the Federal Reserve has recently acknowledged that it underestimated the threat of inflation.

Second, after remaining stubbornly dovish in 2021, or in other words relatively relaxed about keeping rates low, Federal Reserve chairman Jerome Powell has turned far more hawkish, or committed to tightening policy. 

SURGING US INFLATION

The Federal Reserve has been caught off guard by a cost-of-living crisis which has only been exacerbated by the war in Ukraine. For months senior Fed officials dismissed the surge in prices as transitory. They argued it was principally the result of the reopening of the US economy.

The Fed argued that disruptions and shortages would be transitory, and result in a rapid reversal in inflationary pressures. However, price rises accelerated and became increasingly ubiquitous.

The US consumer price index rose by 7.9% through February, the fastest pace of inflation in 40 years. Rising food and rent costs contributed to the increase, as did a nascent surge in gas prices.

The Fed has recently estimated the rate of US inflation would average 4.3% in 2022. This is up from the bank’s 2.6% estimate four months ago and just 1.9% a year earlier.

These seismic changes are decidedly out of character for a conservative central bank that rarely makes big changes to forecasts.

The 16 March outlook by the Federal Reserve for interest rate rises was far more hawkish than the market had anticipated.

The Fed has pencilled in a total of six more rate hikes, excluding the recent 25 basis point rise. It forecasts rates going to 2.8% in 2023 and staying at that level in 2024.

This represents a huge shift in its monetary policy outlook since December when the median view was for only three quarter-point hikes in 2022, and three more in 2023. The next policy announcement is on 4 May.

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