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Most investors were expecting yields to head higher throughout this year, but few were ready for the velocity of the recent surge that has seen the benchmark 10-year Treasury note jump above 1.5%, compared with 1.34% just last Friday.
Even some bond-market veterans have been left searching for historical comparisons, given the surge.
On Thursday, the 10-year Treasury note yield TMUBMUSD10Y, 1.492% rose 13 basis points to 1.51%, around its highest levels in a year, hitting thresholds that investors say have started to weigh on equities and corporate debt.
Bond prices move in the opposite direction of yields.
Although it is hard to pin down the exact reason for surge, here’s what some are attributing to the recent uptrend.
Inflation
For many, rising inflation expectations are the simplest reason for the yield ascent.
The combination of a recovering U.S. economy thanks to vaccination efforts, trillions in fiscal relief and accommodative monetary policy are expected to deliver the kind of inflation that hasn’t been seen since the 2008 financial crisis.
Bond-market forecasts of consumer prices are suggesting inflation could surpass the central bank’s target for a protracted period, and some investors are penciling in at least 3% inflation this year even if they are less sure if such sustained price pressures could last.
The 10-year break-even rate spread, which tracks expectations for inflation among holders of Treasury inflation-protected securities, or TIPS, was at 2.15%. That 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 pent-up savings among U.S. households forced to stay at their homes and restrain their spending in restaurants, leisure and travel.
Once the COVID-19 pandemic is put to bed, consumers would unleash their savings upon the economy, spurring prices for services higher and leading to the kind of elevated price pressures that would usually prompt the central bank to raise rates.
But as part of the central bank’s new average inflation targeting framework, the Fed is likely to stand pat and allow the economy to run hot, adding to concerns that the Fed won’t protect longer-dated Treasurys from reflationary forces.
Insufficient Fed action
Indeed, the lack of willingness on the part of the central bank to lean against rising bond yields has emboldened the bond bears this week.
Fed Chairman Jerome Powell underlined that the central bank would support the economy for as long as necessary, and that the Fed would clearly communicate well in advance when it starts to contemplate tapering asset purchases.
“It’s all just talk,” said Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle Investments, in an interview.
Al-Hussainy said until the central bank backs up its words with concrete actions, such as tweaking its asset purchases, yields could keep moving higher.
Some market participants were unimpressed by the Fed’s nonchalant tone, noting that senior central bankers like Kansas Fed President Esther George kept repeating that higher bond yields reflected improving economic fundamentals and were therefore not a cause for concern.
Thursday’s moves helped to drive selling in equities, with investors repricing those investments as rates jolt higher. The Dow Jones Industrial Average, DJIA, -1.75% the S&P 500 index SPX, -2.45% and the Nasdaq Composite Index COMP, -3.52% all finished sharply lower on the session.
Forced sellers
Market participants also suggested yields were moving beyond fundamental forces, and that inflation fears weren’t enough to explain why rates were moving up at such a ferocious pace.
“A lot of this move is technical,” Gregory Faranello, head of U.S. rates at AmeriVet Securities, told MarketWatch.
He and others suggest the yield surge may have been a case of selling causing more selling, as investors caught offsides were forced to close their bullish positions on Treasury futures, in turn, pushing rates higher.
Ian Lyngen, a rates strategist at BMO Capital Markets, pointed the finger at so-called convexity hedging.
The idea is that holders of mortgage-backed securities will see the average maturities of their portfolio rise in line with higher bond yields, as homeowners stop refinancing their homes.
To offset the risk around holding investments with higher maturities, which can increase the chance of painful losses if rates rise, these mortgage-backed debtholders will sell long-term Treasurys as a hedge.
Usually, selling associated with convexity hedging isn’t powerful enough to drive significant bond-market moves on their own, but when yields are already moving swiftly, it can exacerbate rates swings.
