Bloomberg
Rising treasury yields reflect a warning sign
(Bloomberg opinion) – Yields on U.S. government bonds registered some notable movements in the early days of 2021. If they continue at the current pace, they risk causing headaches for both policymakers and investors. in stocks because of its underlying factors. Within two weeks, the Treasury yield curve experienced a significant increase in yields on longer-term securities, or what is known in the financial markets as “bear steepening”. Yields on 10- and 30-year bonds increased by 20 basis points and 22 basis points, respectively, during this period. Spreads between these maturities and two-year Treasury bills, over which Federal Reserve policy has a significant influence, have increased significantly – from 80 basis points to 98 basis points for 10 years and from 152 basis points to 174 base points for these movements occur when Fed policy has continually sought to suppress yields substantially and keep them in a narrow commercial range. If the moves continue, they would also challenge some of the strong drivers of funds for stocks and other risky assets, reducing their relative attractiveness and weakening the buy signals emitted by models that incorporate the discount of future cash flows. In addition, its persistence would be of concern to the economic outlook because of its underlying drivers and the potential impact on interest-rate sensitive sectors, such as housing. What are these factors? The recent movements in the US yield curve do not reflect any change, real or prospective, in the extremely accommodative orientation of the Fed’s monetary policy. In fact, the minutes of the December Federal Open Market Committee meeting, released last week, reiterated that the central bank has no intention of reducing its stimulus anytime soon, and when it does, the process will be extremely gradual. Some of the other potential contributors to higher yields, such as a higher risk of government default or more favorable growth prospects, are also unlikely. At the very least, the Fed’s willingness to expand its balance sheet without limits reinforces the notion that there is a stable and reliable non-commercial buyer of government bonds. Meanwhile, growth prospects have worsened due to the recent increase in infections, hospitalizations and deaths related to Covid-19. The US monthly employment report on Friday reported a loss of 140,000 jobs in December. The Democratic sweep in Georgia’s two Senate runoff elections last week raised the prospect of higher government budget deficits and much more debt financing. But with the Fed not only committed to maintaining its large-scale asset purchases, but also open to increasing them and shifting more from purchases to longer-term bonds, such a prospect should not have an immediate significant impact on yields. The most likely factors, then, are expectations of higher inflation and more hesitation on the part of Treasury buyers. The first is supported by movements in the inflation breakeven points and other market segments sensitive to inflation. The latter is consistent with the market’s considerable talk about how government bonds, being so highly repressed by the Fed and facing an asymmetrical outlook for yield movements, are no longer ideal for mitigating risk. An intensification of recent movements in yield curves in the weeks to come would be worrisome for policy makers and risk takers in the markets. Although the Fed is expecting higher inflation, it would not want this to materialize through “stagflation” – that is, even more disappointing growth and higher inflation. The Fed has few tools, if any, to steer the economy out of such an operating environment. This, as well as the impact on corporate profits of the lack of economic growth, would exacerbate what is already an extremely large disconnect between financial valuations and fundamentals. The most dominant view of the market at the moment, and it is almost universal, is that stocks and other risky assets will continue to increase due to the abundant liquidity injections from central banks and the allocation of more private funds. After all, central banks are not inclined to moderate their huge stimuli. And investors continue to be strongly conditioned by a powerful mix that has served them extremely well so far: TINA (there is no alternative for stocks) fueling BTD (buy the dip) behavior in response to even the smallest sales in the market, especially due to the FOMO (the fear of losing the recurrence of impressive market highs). As valid as these considerations are at the moment, they also justify close monitoring of the yield curve of US government bonds. A significant continuation of recent trends would challenge the Fed, investors and the economy. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Mohamed A. El-Erian is a columnist for Bloomberg Opinion. He is president of Queens’ College, Cambridge; principal economic consultant for Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO; and president of Gramercy Fund Management. His books include “The Only Game in Town” and “When Markets Collide”. For more articles like this, visit us at bloomberg.com/opinionSubscribe now to keep up to date with the most trusted business news source. © 2021 Bloomberg LP