Us stocks plummeted on Tuesday as Treasury yields soared, coupled with fears of a federal government shutdown, Zhitong Finance reported. At the close of the day, the Dow fell more than 1.5%; the Nasdaq fell 2.83%, the biggest closing decline since March 18; and the S & P 500 fell 2.04%, the biggest one-day decline since May.

The U. S. stock market reacted fiercely to the surge in U. S. bond yields.

The US bond market has sold off since the Fed took a hawkish stance last week, suggesting that investors are more concerned about Fed policy expectations than inflation.

There are plenty of reasons to worry about inflation and the acceleration of price indices throughout the year, but amid all the hustle and bustle that the US economy will return to the 1970s and investor fears of soaring prices, any benchmark inflation hedge bought at the beginning of the year will still lose money.

This trend has been reflected in the past week.

Since the Fed meeting on September 22, the surge in long-term bond yields and the steepening of the yield curve have been largely driven by a rise in "real" yields, while break-even inflation, a clearer indicator of inflation expectations, has risen less and has remained within a certain range since the spring.

So far at least, inflation expectations, as measured by five-to 30-year break-even inflation, have only returned to last month's level, which is still significantly lower than in May.

In addition, measuring inflation expectations in terms of forward swap rates, a clearer measure that excludes the distortions caused by the Fed's quantitative easing on bond markets, shows a similar pattern: it is on an upward trend, but still below mid-year levels.

If the bond market is really worried about the current supply-driven Qualcomm IncInflation will evolve into a permanent, demand-driven phenomenon, and break-even inflation will rise as fast as nominal yields.

Even so, however, the market still has reason to worry about inflation.

Brent crude, for example, recently breached $80 a barrel for the first time in three years, doubling in the past 12 months; core inflation recently reached 4 per cent for the first time in nearly 30 years; and headline inflation slowed in August but remained above 5 per cent.

Phillip Toews, chief executive of Toews Asset Management, said financial markets were too complacent and he thought there was a 50 per cent chance of double-digit inflation in the future.

The driving Force behind the rise in Treasury yields

It is important to identify the driving forces behind the rise in Treasury yields because it shows investors' expectations of the overall inflation outlook and better insight into the minds of policymakers.

As long as break-even inflation remains manageable, there is good reason to believe that bond markets have relatively loose expectations of the inflation outlook and that the Fed can raise interest rates as planned without disrupting financial markets.

However, it could call into question the idea that inflation could spiral out of control, forcing the Fed into a passive rather than active tightening cycle.

The claim is caused by the COVID-19 epidemic, from chip shortages to bottlenecks in the global supply chain where container ships are unable to call at ports, as well as soaring indicators of consumer and corporate inflation expectations.

However, Fed officials insist this is temporary, although it may last longer than they previously thought.

The Fed said last week that nine of its 18 policy makers were expected to start raising interest rates in 2022, up from seven in June, while the median forecast had shifted to a faster pace of tightening. They expect inflation to remain above the Fed's 2 per cent target by 2024.

However, at least this year, fighting inflation by buying inflation-protected bonds (Treasury Inflation-Protected Securities) remains a risk trade. Yields on 10-year inflation-protected bonds are down about 1.5% this year, according to the data. 30-year inflation-protected bonds are down nearly 7%. Since the fed's meeting on September 22nd, bonds of these two maturities have fallen by about 1% and 4%, respectively.

This means that the "real" yield, which explains inflation, has risen sharply: the real yield on the 10-year Treasury note is at an all-time low of 1.2 per cent in early August. It is now-0.85%, which is equivalent to an increase of 35 basis points.

This is almost exactly the same as the increase in the nominal yield of 10-year Treasuries from 1.18% to 1.53% over the same period of time, coupled with a slowdown in break-even inflation.This suggests that investors are repricing the Fed's response rather than a permanent rise in inflation.

Finally, according to JPMorgan Chase & CoA customer survey conducted last week showed that 54 per cent thought supply restrictions were temporary and 43 per cent thought supply restrictions would persist. And even if that balance is reversed, break-even inflation suggests that investors are still confident that the Fed will act quickly enough to contain the more damaging rise in inflation.