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Most investors expected yields to rise throughout this year, but few were ready for the speed of the recent surge that saw benchmark 10-year T-bills rise above. 1.5%, against 1.34% last Friday.
Even some bond market veterans have been left looking for historical comparisons given the surge.
The 10-year Treasury bill on Thursday yields TMUBMUSD10Y,
rose 13 basis points to 1.51%, around its highest levels in a year, hitting thresholds that investors say have started to weigh on stocks and corporate debt.
Bond prices move in the opposite direction of yields.
While it’s difficult to pinpoint the exact reason for the surge, here’s what some attribute to the recent uptrend.
Inflation
For many, rising inflation expectations are the simplest reason for the rate hike.
The combination of a recovering US economy from vaccination efforts, billions of billions in tax breaks and accommodative monetary policy are expected to result in the kind of inflation that has not been seen since the 2008 financial crisis. .
The bond market outlook for consumer prices suggests that inflation could exceed the central bank’s target for an extended period, and some investors are marking inflation of at least 3% this year, even though they are less certain that such sustained pressure on prices could last.
The 10-year break-even rate differential, which tracks the inflation expectations of holders of Inflation-Protected Treasury Securities, or TIPS, was 2.15%. That’s well above the Fed’s typical annual target of 2%.
Scott Clemons, chief investment strategist at Brown Brothers Harriman, says another factor that could push prices up later this year is the savings accumulated among U.S. households forced to stay at home and limit spending in restaurants, recreation and travel.
Once the COVID-19 pandemic fell asleep, consumers would unleash their savings on the economy, raising the prices of services and causing the kind of high price pressures that would typically prompt the central bank to raise rates.
But under the central bank’s new average inflation targeting framework, the Fed is expected to hold on and allow the economy to warm up, adding to fears that the Fed will not protect Treasuries any longer. term of reflationary forces.
Insufficient action by the Fed
Indeed, the central bank’s unwillingness to lean against rising bond yields emboldened bond bears this week.
Fed Chairman Jerome Powell stressed that the central bank will support the economy for as long as needed and that the Fed will communicate clearly well in advance when it begins to consider phasing out asset purchases.
“It’s all talk,” Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle Investments, said in an interview.
Al-Hussainy said that until the central bank backs up its words with concrete actions, such as changing its asset purchases, yields may continue to rise.
Some market participants were unimpressed by the Fed’s nonchalant tone, noting that major central bankers like Kansas Fed Chairman Esther George kept repeating that higher bond yields reflected the improving economic fundamentals and therefore were not of concern.
See: Short-term Treasury rate hike could come into ‘direct conflict’ with easy Fed policy, broker warns
Thursday’s moves helped boost stock selling, as investors repricing those investments as rates soar. The Dow Jones Industrial Average, DJIA,
the S&P 500 SPX index,
and the Nasdaq Composite Index COMP,
all finished significantly lower in the session.
Forced sellers
Market participants also suggested that yields were exceeding fundamental forces and that inflation fears were not enough to explain why rates were rising at such a fierce pace.
“Much of this decision is technical,” Gregory Faranello, head of US rates at AmeriVet Securities, told MarketWatch.
He and others suggest that the surge in yields may have been a case of selling leading to more selling, as investors caught off guard were forced to close their bullish positions in Treasury futures, in turn pushing rates on the rise.
Ian Lyngen, rate strategist at BMO Capital Markets, pointed to the so-called convexity hedge.
The idea is that holders of mortgage-backed securities will see their average portfolio maturities increase along with higher bond yields as homeowners stop refinancing their homes.
To offset the risk of holding investments with longer maturities, which can increase the risk of painful losses if rates rise, these mortgage holders will sell long-term treasury bills as cover.
Usually, the sell associated with convexity hedging is not strong enough to drive large bond market moves on its own, but when yields are already moving rapidly, it can exacerbate rate movements.
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