Oversight of Treasury Department's and Federal Reserve's Pandemic Response hearing in Washington
Treasury Secretary Steven Mnuchin testifies before a House Financial Services Committee hearing on “Oversight of the Treasury Department’s and Federal Reserve’s Pandemic Response” in the Rayburn House Office Building in Washington, U.S., December 2, 2020. Jim Lo Scalzo/Pool via REUTERS

December 2, 2020

By Kate Duguid

NEW YORK (Reuters) – Market expectations of U.S. inflation on Wednesday were headed higher on renewed hopes that Congress could pass a COVID-19 stimulus package, after they reached 18-month highs in the prior session.

The 5-year, 10-year and 30-year breakeven inflation rates all closed on Tuesday at their highest since May 2019 and moved higher in trading on Wednesday. The 5-year breakeven was last at 1.759%, the 10-year at 1.852% and the 30-year at 1.974%.

Another measure of inflation, which tracks the expected rate over five years in five years’ time, on Tuesday hit 1.86%, its highest since Oct. 21.

The 30-year yield, which is particularly sensitive to inflation expectations as rising consumer prices can erode its value, has risen to near four-month highs. The yield is up about 50 basis points since August when Federal Reserve Chair Jerome Powell announced that the central bank would allow periods of higher inflation in order to average its target 2% rate.

Wednesday’s move came after Treasury Secretary Steven Mnuchin said President Donald Trump supported a coronavirus relief proposal put forth by Republican Majority Leader Mitch McConnell. He rejected on Tuesday a $908-billion bipartisan package. It is unclear whether the measure would have the votes to pass the Democratic-controlled House of Representatives.

In traditional models of inflation, large increases in government spending would weaken the purchasing power of the dollar, and therefore drive inflation higher. However, inflation did not return to pre-crisis levels when stimulus measures were put into effect after the 2007-2009 financial crisis and have consistently averaged well below the 2% target set by the U.S. Federal Reserve.

“I do think inflation is coming, I do think inflation will be a problem, I do think the Fed is going to have to deal with it. I don’t know how quickly it is going to come, but I do think it is going to be here somewhere next year,” said Andrew Brenner, head of international fixed income at NatAlliance.

(Reporting by Kate Duguid, Editing by Franklin Paul and Nick Zieminski)

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