Most investors expected returns to be higher during this year, but few were ready for the speed of the recent upswing, which raised the standard 10-year treasury note to above 1.5% compared to 1.34 % only last Friday.
Even some veterans in the bond market are looking for historical comparisons, given the boom.
On Thursday, the 10-year Treasury returns TMUBMUSD10Y,
rose by 13 basis points to 1.51%, about its highest levels in a year, and hit the thresholds which, according to investors, began to weigh equities and corporate debt.
Bond prices are moving in the opposite direction of returns.
While it is difficult to determine the exact reason for the surge, it is what some attribute to the recent upward trend.
Inflation
For many, rising inflation expectations are the simplest reason for yield growth.
The combination of a recovering US economy thanks to vaccination efforts, trillions of fiscal easing and accommodative monetary policies is expected to deliver the kind of inflation that has not been seen since the 2008 financial crisis.
Forecasts on consumer market prices suggest that inflation may exceed the central bank’s target for the long term, and some investors are giving inflation at least 3% this year, even if they are less sure whether such sustained price pressures could last.
The 10-year break-even rate spread, which keeps expectations of inflation among the holders of inflation-protected bonds, or TIPS, by the Treasury, 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 push prices higher later this year is the sharpened savings among U.S. households who are forced to stay at their homes and limit their spending on restaurants, recreation and travel.
Once the COVID-19 pandemic is put to bed, consumers will abandon their savings on the economy, which will drive up prices for services and lead to the kind of increased price pressure that the central bank will usually raise rates.
But as part of the central bank’s new average inflation targeting framework, the Fed is likely to beat and warm up the economy, adding to concerns that the Fed will no longer protect dated Treasuries from inflationary forces.
Insufficient Fed action
The central bank’s lack of willingness to support rising bond yields has encouraged the effects of the bonds this week.
Jerome Powell, chairman of the Fed, stressed that the central bank would have to support the economy for as long as it needed to and that the Fed would clearly communicate well in advance when it starts buying the decline in assets.
“It’s all just talk,” Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle Investments, said in an interview.
Al-Hussainy said until the central bank backs up its words with concrete actions, such as adjusting its asset purchases, returns could continue to move higher.
Some market participants were not impressed by the Fed’s nonchalant tone, noting that senior central bankers such as Kansas President Esther George have repeatedly reiterated that higher bond yields reflect the improvement in economic principles. and thus there was no cause for concern.
See: Rise in short-term treasury rates could ‘directly conflict’ with easy Fed policies, warns broker
Thursday’s move helped boost stock sales, and investors recalculated the investments as rates rose. The Dow Jones Industrial Average, DJIA,
the S&P 500 index SPX,
and the Nasdaq Composite Index COMP,
all ended sharply lower on the session.
Forced sellers
Market participants also suggested that yields go beyond fundamental forces, and that fear of inflation is not enough to explain why rates are rising at such a furious pace.
“A lot of this step is technical,” Gregory Faranello, head of US rates at AmeriVet Securities, told MarketWatch.
He and others suggest that the rate of return could be a case that caused more sales because investors who were not on the sidelines were forced to close their positive positions on the future of the treasury, which in turn raises the rate has.
Ian Lyngen, a tariff strategist at BMO Capital Markets, pointed the finger at so-called convexity hedging.
The idea is that mortgage loan holders will see the average maturity of their portfolio rise in line with higher returns as homeowners stop refinancing their homes.
To offset the risk against investments with a higher maturity, which could increase the chance of painful losses as rates rise, these related debtors will sell long-term Treasurys as a hedge.
Usually, sales related to convex hedging are not strong enough to drive significant movements in the bond market per se, but if yields are already moving fast, this could exacerbate the interest rate swing.