Most investors expected yields to rise throughout this year, but few were prepared for the pace of recent growth that saw the 10-year Treasury benchmark rise above 1.5% from 1.34% on Friday. past.
Even some veterans of the bond market have been left to look for historical comparisons, given the growth.
On Thursday, the 10-year treasury bill produced TMUBMUSD10Y,
rose 13 basis points to 1.51% around its highest levels in the past year, reaching thresholds investors say they have begun to care about shares and corporate debt.
Bond prices are moving in the opposite direction to yields.
Although it is difficult to identify the exact reason for the growth, this is what some attribute to the recent upward trend.
Inflation
For many, rising inflation expectations are the simplest reason for rising yields.
The combination of a recovering US economy due to vaccination efforts, trillions of tax exemptions and accommodative monetary policy is expected to produce a type of inflation that has not been seen since the 2008 financial crisis.
Consumer bond market forecasts suggest that inflation could exceed the central bank’s target for the long term, and some investors are creating inflation of at least 3% this year, although they are less sure if such sustained price pressures could hard.
The spread over the 10-year rate of return, which follows inflation expectations among holders of inflation-protected government securities, or TIPS, was 2.15%. This is well above the Fed’s typical annual target of 2%.
Scott Clemons, chief investment strategist at Brown Brothers Harriman, says another factor that could drive up prices later this year is the savings accrued among U.S. households forced to stay in their homes and cut back on spending on restaurants, entertainment and travels.
Once the COVID-19 pandemic is put to bed, consumers will unleash their savings on the economy, boosting higher service prices and leading to the kind of high price pressures that would usually cause the central bank to raise rates.
But as part of the central bank’s new medium-term inflation targeting framework, the Fed is likely to stay afloat and allow the economy to stay warm, adding to concerns that the Fed will not protect the Treasury with older data from reflective forces.
Insufficient Fed action
Indeed, the central bank’s unwillingness to rely on rising bond yields has encouraged bond yields this week.
Fed Chairman Jerome Powell stressed that the central bank will support the economy for as long as necessary and that the Fed will clearly communicate well in advance when it begins to consider low-asset purchases.
“It’s just that,” said Ed Al-Hussainy, a senior interest rate and foreign exchange analyst at Columbia Threadneedle Investments, in an interview.
Al-Hussainy said until the central bank backs down with concrete actions, such as changing its asset acquisitions, yields could continue to move.
Some market participants were not impressed by the Fed’s nonchalant tone, noting that senior central bankers, such as Kansas Fed President Esther George, have continued to repeat that higher bond yields reflect improved economic fundamentals and therefore do not represent a cause for concern.
See: Rising short-term treasury rates could come into “direct conflict” with Fed’s light policy, warns broker dealer
Thursday’s moves helped boost stock sales, with investors recovering as investments rose further. Dow Jones Industrial Average, DJIA,
the S&P 500 SPX index,
and Nasdaq Composite Index COMP,
they all ended abruptly below the session.
Forced sellers
Market participants also suggested that yields exceeded fundamental forces and that the fear of inflation was not enough to explain why rates were rising at such a fierce pace.
“Much of this move is technical,” Gregory Faranello, head of U.S. tariffs at AmeriVet Securities, told MarketWatch.
He and others suggest that the increase in yield could have been a case of selling that led to more sales, as offside investors were forced to close their positions in the future of the Treasury, in turn, pushing higher rates.
Ian Lyngen, tariff strategist at BMO Capital Markets, pointed to the so-called convexity coverage.
The point is that mortgage-backed holders will see the average maturities of their portfolio grow, in line with higher bond yields, as homeowners stop refinancing their homes.
To offset the risk of holding investments with longer maturities, which can increase the chances of painful losses if rates rise, these mortgage borrowers will sell long-term treasuries as hedging.
Usually, selling associated with convexity hedging is not strong enough to drive significant bond market movements on its own, but when yields move rapidly, it can exacerbate rate fluctuations.