The tumult in the bond market puts “down for more” in Crosshairs

A number of Federal Reserve officials said the rise was a healthy one, reflecting investors’ improved expectations for a vaccine-boosted economic stimulus. Many portfolio managers say they believe rates will flatten in the coming days as yields eventually reach attractive levels. These views will receive a new test this week, with Fed Chairman Jerome Powell set to make a public appearance on Thursday and the release of the February job report on Friday.

But there are signs, such as the unusually weak demand for recent Treasury debt auctions, that the sale may not have ended and yields should rise. Some traders warn that bond markets signal a strong economic recovery that could lift the momentum that has kept borrowing costs low while fueling stocks to record – potentially a recipe for more difficult transactions seen in the past week, when the Dow industry more than 1,000 points in three days.

“There is a view that the recovery from a pandemic looks different from that of a normal recession,” said Michael de Pass, global head of US Treasury trading at Citadel Securities.

Traders said the momentum was evident at a Treasury auction late last week. The five-year and seven-year treasury demand was weak on Thursday, heading for a $ 62 billion seven-year ticket auction and almost evaporated in the minutes following the auction, which was one of the lowest received by analysts and -they could remember.

The seven-year ticket was sold at a yield of 1.195%, or 0.043 percentage points higher than traders had expected – a record gap for a seven-year ticket auction, according to analysts Jefferies LLC. Primary dealers, large financial firms that can trade directly with the Fed and are required to bid at auctions, were left with about 40 percent of the new notes, about twice the recent average.

Warm demand has worried investors, as the government is expected to sell a huge amount of debt in the coming months to pay for the stimulus efforts behind the recovery. Other poor auction results could fuel additional sales in bond markets and undermine the tone in other markets, such as equities, investors said.

Analysts believed that an increased supply of Treasurys could weigh on the market during the year, but “it’s very different when you’re dealing with it,” said Blake Gwinn, head of US strategy at NatWest Markets.

Some traders said that recent movements have been exacerbated by the conduct of popular transactions involving the purchase of short-term cash and the sale of other assets against them. Many highlighted one in particular: the holders’ effort to protect their mortgage investments against rising yields, a practice known in the language of the industry as convexity hedging.

Reductions in Fed rates over the past year have fueled a surge in home sales and refinancing, but the recent rise in yields has pushed mortgage rates to their highest level since November last week and applications have fallen. This forces banks and other holders, such as real estate investment trusts, to sell treasuries to offset losses on mortgage bonds that occur when consumers stop refinancing.

Market-based inflation measurement moves are also a cause for concern. Rising prices are affecting the purchasing power of fixed bond payments and could force the Fed to raise rates sooner than expected. While inflation has stalled for years, usually below the Fed’s 2% target, some fear that the economic reopening and stimulus efforts by the Fed and Congress could trigger an acceleration.

The five-year rate of return – a measure of annual inflation projected over the next five years, derived from the difference between five-year Treasury yields and inflation-protected equivalent securities – has reached 2.4% in recent days, the highest since May 2011.

“The question is whether 2% inflation can be sustained once we reach it,” said Matthew Hornbach, global head of macro strategy at Morgan Stanley..

He said the magnitude of the US fiscal stimulus meant that inflation “has a very reasonable chance of reaching 2% and staying there”.

At the same time, the recent increase in Treasury yields did not only reflect rising inflation expectations, as was essentially the case at the beginning of the year. In the last two weeks, inflation-protected government bond yields – a proxy for so-called real yields – have also risen, with the 10-year TIPS yield rising from about minus 1% to minus 0.7%.

This move has attracted the attention of investors as many credit deep negative real profits, helping energy stocks to record, pushing investors looking for returns to riskier assets. Real yields were around zero percent or higher from mid-2013 to early 2020, which means they could have more room for growth even after their recent move.

The yield on the 10-year US Treasury benchmark was set at 1.459% on Friday, down from 1.513% a day earlier, but from 1.344% at the end of the previous week.

For now, many investors are turning to assets that are less vulnerable to rate fluctuations. Shares are less competitive with bonds when yields rise. Shares in some of the most popular technology stocks, including Amazon.com and Apple,

they have fallen from their highs in the last month.

Rick Rieder, director of global fixed income investment at BlackRock Inc., said his team bought floating rate loans rather than bonds to protect against rising interest rates and benefit from the economic recovery.

“We have turned much of our exposure to high-yield bonds into loans,” Mr Rieder said. “Real rates were negative at 1%. Eventually they move, but they still have something to do, which will lead to higher interest rates than current levels. ”

Write to Julia-Ambra Verlaine at [email protected] and Sam Goldfarb at [email protected]