Most investors expected yields to rise over the course of this year, but few were prepared for the speed of the recent hike, which saw the 10-year Treasury bill jump to more than 1.5%, compared to 1.34% Last Friday.
Even some bond market veterans have been looking for historical comparisons due to the increase.
On Thursday, the 10-year Treasury bill yielded TMUBMUSD10Y,
rose 13 basis points to 1.51%, around its highest levels in a year, reaching levels that investors say began to weigh on stocks and corporate debt.
Bond prices move in the opposite direction from earnings.
While it is difficult to determine the exact reason for the peak, here is what some attribute to the recent upward trend.
Inflation
For many, rising inflation expectations are the simplest reason for rising income.
The combination of a recovering American economy thanks to vaccination efforts, trillions in fiscal relief and accommodative monetary policy are expected to generate the kind of inflation that has not been seen since the 2008 financial crisis.
Securities market forecasts for consumer prices are suggesting that inflation may exceed the central bank’s target for an extended period, and some investors are forecasting inflation of at least 3% this year, even if they are not so sure whether such sustained price pressures could last.
The 10-year equilibrium rate spread, which follows inflation expectations among holders of securities protected by Treasury inflation, 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 pent-up economy among American families forced to stay in their homes and restrict spending on restaurants, leisure and travel.
Once the COVID-19 pandemic is eliminated, consumers will release their savings in the economy, raising service prices and leading to the kind of high price pressure that would normally lead the central bank to raise rates.
But as part of the central bank’s new average inflation targeting structure, the Fed is likely to remain firm and allow the economy to warm up, raising concerns that the Fed will not protect the long-term Treasury from reflective forces.
Insufficient Fed action
Indeed, the central bank’s unwillingness to lean against rising bond yields encouraged bond bears 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 in advance when it begins to consider reducing asset purchases.
“It’s all talk,” said Ed Al-Hussainy, a senior interest and exchange analyst at Columbia Threadneedle Investments, in an interview.
Al-Hussainy said that until the central bank supports its words with concrete actions, such as adjustments in asset purchases, yields may continue to rise.
Some market participants were not impressed by the Fed’s indifferent tone, noting that senior central bankers, such as Kansas Fed President Esther George, repeated that higher bond yields reflected improved economic fundamentals and therefore were not cause for concern.
To see: Increase in short-term Treasury rates could enter ‘direct conflict’ with easy Fed policy, warns broker
Thursday’s moves helped to boost the sale of shares, with investors repricing those investments as rates rise. The Dow Jones Industrial Average, DJIA,
the S&P 500 SPX index,
and the Nasdaq Composite Index COMP,
all ended in a sharp drop in the session.
Forced sellers
Market participants also suggested that yields were going beyond fundamental forces and that fears of inflation were not enough to explain why rates were rising at such a fierce pace.
“A lot of this movement is technical,” Gregory Faranello, head of US rates at AmeriVet Securities, told MarketWatch.
He and others suggest that the yield increase may have been a case of selling, causing more sales, as investors took their disadvantages and were forced to close their bullish positions on Treasury futures, pushing rates higher.
Ian Lyngen, rate strategist at BMO Capital Markets, pointed a finger at the so-called convexity hedge.
The idea is that holders of mortgage-backed securities will see average portfolio maturities increase in line with higher bond yields, as homeowners stop refinancing their homes.
To offset the risk of holding investments with higher maturities, which may increase the chance of painful losses if rates rise, these mortgage-backed lenders will sell long-term Treasury bonds as hedges.
Typically, the sale associated with convexity coverage is not powerful enough to drive significant movements in the bond market on its own, but when yields are already moving fast, it can exacerbate rate swings.