U.S. Treasury yields have shot higher this year, rising faster than many forecast. Investors are now assessing if anticipation of a more hawkish Fed will continue to push levels up, with the potential to upset riskier assets.
Expectations that the U.S. Federal Reserve may increase rates more aggressively than anticipated to counter rising inflation have pushed up yields while flattening the U.S. Treasury yield curve. That matters as bond yields impact global asset prices as well as consumer loans and mortgages. The shape of the U.S. Treasury yield curve can also help predict how the economy will fare.
On Thursday, yields on 10-year notes hit 2% after higher-than-anticipated inflation data. Federal funds rate futures showed an increased chance of a half percentage-point tightening at next month’s meeting after the data, while strategists said the data increased the chances of swifter moves to reduce the Fed’s balance sheet. The central bank’s nearly $9 trillion portfolio doubled in size during the pandemic.
“The market is starting to price in a much more aggressive path of rate hikes ... clearly there is a sense of urgency again,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale.
Yields, which move inversely to prices, are up from 1.79% at the beginning of February. The last time they breached 2% was August 2019.
“I would say the chances of yields continuing to go higher are pretty high,” said Gargi Chaudhuri, Head of iShares Investment Strategy, Americas, at BlackRock, speaking ahead of the data.
Competition in other markets for yield may be sapping demand for Treasuries and helping push yields higher, Chaudhuri said.
A second rate hike by the Bank of England last week, and expectations of faster policy tightening by the European Central Bank (ECB), added to U.S. bonds’ weakness, with borrowing costs in Europe - as well as Japanese government bond yields - having jumped to multi-year highs in recent days.
“Investors have these other markets to gravitate towards that they didn’t in the past, and that will require investors that are focusing on U.S. markets to seek a higher term premium and therefore will impact yields higher,” Chaudhuri said.
Japan’s benchmark 10-year government bond yield is around its highest level since January 2016 at 0.220% while Germany’s 10-year government bond yield , at 0.255%, is at its highest since January 2019.
For Kelsey Berro, fixed income portfolio manager at J.P. Morgan Asset Management, the level of yields in overseas markets such as Japan or Germany have made U.S. rates comparably more attractive, preventing a sustainable sell off, but that is expected to change.
“Already you should start to see that some of these foreign investors take a second look at their home countries rather than reaching for yields in the U.S.,” she said.
Still, there was strong demand seen for a recent 10-year Treasury auction, although it was unclear how much overseas bidders participated.
The rise in US yields has come faster than many anticipated: In December, a Reuters poll forecast that 10-year note yields would rise to around 2% towards the end of 2022 - a level it has reached in the first couple of months.
Some banks have been updating that view. Goldman Sachs analysts on Wednesday raised their forecast for the U.S. 10-year Treasury yield to 2.25% by end-2022, from a previous year-end target of 2%.
The pace of gains has caused volatility in other assets. U.S. equities have been rocky this year, with shares of tech companies particularly volatile, as expectations of higher yields threaten to erode the value of their future earnings.
Gene Podkaminer, Head of Research for Franklin Templeton Investment Solutions, called 2% on the benchmark 10-year a “psychological” level that could make U.S. government bonds more attractive versus other assets, such as volatile stocks.
“When you start getting close to 2% ... all of a sudden Treasuries are looking more appealing,” Podkaminer said earlier this week.
One commonly cited metric still favors stocks, however.
The equity risk premium – or the extra return investors receive for holding stocks over risk-free government bonds – favors equities over the next year, Keith Lerner, co-chief investment officer at Truist Advisory Services, said on Wednesday.
The S&P 500 has historically beaten the one-year return for the 10-year Treasury note by an average of 11.8% when the premium stood at Wednesday’s level of 260 points, Lerner said.
“I don’t think the U.S. 10-year yield hitting 2% would have a big impact on the stock markets per se,” said Manish Kabra, head of U.S. equity strategy at Societe Generale, citing the equity risk premium.
However, “we could see some pressure if yields go to 2.5%,” she said.
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