Most investors expected yields to rise higher this year, but few were ready for the speed of the recent rise, pushing the 10-year benchmark Treasury bill above 1.5% from 1.34% last Friday.
Even some bond market veterans are looking for historical comparisons given the surge.
On Thursday, the 10-year Treasury will yield TMUBMUSD10Y,
rose 13 basis points to 1.51%, around its highest level in a year, reaching thresholds that investors believe were starting to weigh on stocks and corporate debt.
Bond prices move in the opposite direction to yields.
While it is difficult to pinpoint the exact reason for the rise, it is what some attribute to the recent uptrend.
Inflation
For many, rising inflation expectations are the simplest reason for the rise in interest rates.
The combination of a recovering US economy driven by vaccination efforts, trillions of fiscal relief, and accommodative monetary policy is expected to deliver the kind of inflation that has not occurred since the 2008 financial crisis.
Consumer price projections in bond markets suggest that inflation could exceed the central bank’s target for a longer period of time, and some investors are expecting inflation of at least 3% this year, even if they are less confident whether such sustained price pressure could continue.
The 10-year break-even spread, which tracks inflation expectations among holders of inflation-protected Treasuries, or TIPS, was 2.15%. That’s 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 prices up later this year is the accumulated savings of American households forced to stay at home and limit their spending in restaurants, leisure time and travel.
Once the COVID-19 pandemic is put to bed, consumers would unleash their savings on the economy, driving up prices for services and creating the kind of increased price pressure that would usually prompt the central bank to raise rates.
But as part of the central bank’s new target framework for average inflation, the Fed is likely to hold its ground and allow the economy to thrive, adding to concerns that the Fed will not protect longer-dated government bonds from reflationary forces.
Insufficient action from the Fed
Indeed, the central bank’s lack of willingness on the part of the central bank to counter rising bond rates has encouraged bond bears this week.
Fed Chairman Jerome Powell underlined that the central bank would support the economy for as long as needed, and that the Fed would clearly communicate well in advance when it begins to consider phasing out asset purchases.
“It’s all just talk,” Ed Al-Hussainy, senior interest and currency analyst at Columbia Threadneedle Investments, said in an interview.
Al-Hussainy said interest rates could continue to rise until the central bank backs up its words with concrete actions, such as adjusting its asset purchases.
Some market participants were unimpressed by the Fed’s casual tone, noting that senior central bankers such as Kansas Fed president Esther George continued to reiterate that higher bond yields reflected improving economic fundamentals and therefore were not a cause for concern.
SeeRise in short-term Treasury yields could come into ‘direct conflict’ with simple Fed policy, broker-dealer warns
Thursday’s moves helped boost stock sales, with investors rearranging those investments as interest rates shot higher. The Dow Jones Industrial Average, DJIA,
the S&P 500 index SPX,
and the Nasdaq Composite Index COMP,
everything ended sharply lower on the session.
Forced sellers
Market participants also suggested that yields exceed fundamental forces and that inflation fears were not enough to explain why interest rates were rising so quickly.
“Much of this movement is technical,” Gregory Faranello, US rates chief at AmeriVet Securities, told MarketWatch.
He and others suggest that the rise in yields may have been a case of sales that triggered more sales, as investors who were sidelined were forced to close their bullish positions on treasury futures, driving interest rates higher.
Ian Lyngen, price strategist at BMO Capital Markets, pointed the finger at the so-called convexity hedge.
The idea is that holders of mortgage-backed securities will see the average maturities of their portfolios rise 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 likelihood of painful losses if interest rates rise, these mortgage-backed debtors will sell long-term treasuries as hedging.
Usually, convexity hedging selling is not powerful enough to drive significant movements in the bond market itself, but when interest rates move quickly, it can exacerbate interest rate fluctuations.