By Sam Goldfarb 

Investors are hanging on to bonds that protect against inflation even as they sell other U.S. government debt, a sign many trust the Federal Reserve to hold interest rates steady even if the economy picks up steam.

In recent trading, the yield on the 10-year Treasury inflation-protected security was minus 1.047%, according to Tradeweb, compared with minus 1.032% on Tuesday.

The 10-year TIPS yield has climbed slightly from its record closing low of minus 1.115% set on Jan. 4 but not nearly as much as the yield on the regular 10-year Treasury note. That yield, a benchmark rate for borrowing costs throughout the economy, has jumped to 1.090% in recent trading from 0.915% on Jan. 4. Yields rise when bond prices fall.

Taken together, these moves suggest investors increasingly expect higher inflation, but not rate increases from the Fed, analysts said.

Over the past several months, market-based measures of investors' inflation expectations have risen, based on the belief that a combination of coronavirus vaccines, increased government spending and continued support from the Fed will lead to a strong economic rebound this year.

Inflation expectations and nominal Treasury yields got an extra boost two weeks ago when Democrats won two Senate runoff elections -- giving them narrow control over both chambers of Congress, along with the White House.

Those results opened up the possibility for even more government spending than investors previously anticipated. Meanwhile, Fed officials have indicated that they aren't close to raising interest rates, having adopted a new policy framework last year that aims to push inflation above their 2% target for a period so that it doesn't languish below that level.

Yields on Treasury inflation-protected securities, or TIPS, are a proxy for what investors call real Treasury yields -- or the return on regular Treasurys after adjusting for inflation.

Negative real yields tend to push investors into riskier assets such as stocks and corporate bonds in search of positive returns. They also suggest that many investors -- even as they increase their inflation expectations -- aren't overly worried about runaway inflation, which would force the Fed to raise rates.

"The Fed won't worry too much about higher nominal interest rates as long as the move higher is led by inflation expectations, because that would mean that real interest rates remain negative and Fed policy remains accommodative," said Donald Ellenberger, senior portfolio manager at Federated Hermes.

Mr. Ellenberger said his multisector bond fund, the Federated Hermes Total Return Bond Fund, has increased its holdings of TIPS to 7% of the portfolio from 4.5% last May due the growing risk of higher inflation caused by what he sees as a new era of larger federal budget deficits combined with easy-money Fed policies.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

January 20, 2021 13:58 ET (18:58 GMT)

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