Most investors expected yields to rise over the course of this year, but few were prepared for the pace of the recent rise that has seen the ten-year benchmark treasury note exceed 1.5%, compared to 1.34% last Friday.
Even some veterans of the bond market have been looking for historical comparisons, given the rise.
On Thursday, the 10-year Treasury note produces TMUBMUSD10Y,
it rose 13 basis points to 1.51%, around its highest levels in a year, and exceeded thresholds investors say they have begun to weigh on equities and corporate debt.
Bond prices move in the opposite direction of yields.
While it is difficult to determine the exact reason for the rise, this is what some attribute to the recent uptrend.
Inflation
For many, rising inflation expectations are the simplest reason for the rise in yields.
The combination of a recovering U.S. economy thanks to vaccination efforts, billions in fiscal relief, and accommodative monetary policy is expected to produce the kind of inflation that has not been seen since the US financial crisis. 2008.
Consumer bond market forecasts suggest that inflation could exceed the central bank’s target for an extended period, and some investors have a minimum inflation of 3% this year, although they are less sure whether these sustained prices could last.
The ten-year equilibrium rate differential, which tracks inflation expectations among holders of Treasury inflation-protected securities, or TIPS, stood at 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 accumulated savings among U.S. households forced to stay home and restrict the spending on restaurants, leisure and travel.
Once the COVID-19 pandemic is put to bed, consumers would unleash their savings on the economy, driving higher service prices and causing the kind of high price pressures that would normally force 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 remain affected and allow the economy to warm up, adding to concerns that the Fed will not it will protect the oldest treasures of the reflationist forces.
Insufficient Fed action
In fact, the central bank’s unwillingness to rely on rising bond yields has encouraged bonds this week.
Fed Chairman Jerome Powell stressed that the central bank would support the economy for as long as necessary and that the Fed would communicate clearly in advance when it comes to considering reducing asset purchases.
“It’s all about talking,” Ed Al-Hussainy, a senior interest and foreign exchange analyst at Columbia Threadneedle Investments, said in an interview.
Al-Hussainy said that as long as the central bank backs up its words with concrete actions, such as modifying asset purchases, yields could continue to rise.
Some market participants were not impressed by the Fed’s distressed tone, noting that central bankers such as Kansas Fed Chairman Esther George reiterated that higher bond yields reflected improved economic fundamentals and, therefore, they were not a cause for concern.
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Thursday’s moves helped drive equities selling, and investors reassessed those investments as rates rise. The Dow Jones Industrial Average, DJIA,
the S&P 500 SPX index,
and the Nasdaq Composite Index COMP,
it all ended abruptly in the session.
Forced sellers
Market participants also suggested that yields exceeded fundamental forces and that fears of inflation were 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. fees at AmeriVet Securities, told MarketWatch.
He and others suggest that the rise in yield could have been a sell-off that led to more sales, as investors caught offside were forced to close their bullish positions in Treasury futures, in turn, rising the types.
Ian Lyngen, rate strategist at BMO Capital Markets, pointed to the so-called convexity coverage.
The idea is for mortgage-backed holders to see their average portfolio maturities increase in line with higher bond yields as homeowners stop refinancing their homes.
To offset the risk associated with holding investments with higher maturities, which can increase the possibility of painful losses if rates rise, these mortgage-backed debt holders will sell long-term treasuries as hedging.
Normally, selling associated with convexity hedging is not strong enough to drive significant bond market movements on its own, but when yields are already moving rapidly, it can exacerbate rate changes.