The worst bond decline in decades reached a new stage on Monday, with 10-year bond yields reaching 3% for the first time since the end of 2018.
Yields on benchmark 10-year government securities, which rose as bond prices fell, rose early in US trading to 3.002% in the afternoon as traders prepared for the outcome of this week’s Federal Reserve meeting. It then fell just below 3% to 2.995% from 2.885% on Friday.
A reference to the cost of loans for everything from mortgages to student loans, the yield last closed above 3% in November 2018 and jumped from 1.496% at the end of last year.
Government bond, corporate bond and municipal debt prices have fallen this year in response to the Fed’s efforts to raise interest rates in a bid to curb inflation. Bloomberg’s US bond index – mostly US government bonds, high-rated corporate bonds and mortgage-backed securities – returned minus 9.5% this year to April 29.
“It’s been a tough few months,” said Nick Hayes, head of fixed income and fixed income distribution at AXA Investment Managers.
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Bond yields largely reflect investors’ expectations of short-term interest rates over the life of the bond. Rising yields are often associated with a booming economy, as faster growth and a tighter labor market can help central banks cope with inflation.
In this case, the labor market is extremely tight and inflation is at its fastest pace in decades, which led the Fed to signal a rapid series of interest rate hikes and caused a sharp rise in profitability, which sent shockwaves through the markets.
Investors are unlikely to get much relief until inflation fears subside, which is an incredible picture when Covid-19 outbreaks in Asia put pressure on global supply chains and the war in Ukraine raises commodity prices, said Zachary Griffiths, senior. macro-strategist at Wells Fargo.
“There is a lot of uncertainty about inflation, monetary policy, geopolitics,” Mr Griffiths said. “Even when the Fed signals that it will tighten significantly, it still does not seem to lower inflation expectations, not permanently.
The reversal of the US government bond yield curve has been seen as a warning sign of a recession for decades and looks set to shine again. WSJ’s Dion Rabuin explains why the reverse yield curve can be so reliable in predicting a recession and why market watchers are talking about it now. Illustration: Ryan Trefs
Fed officials raised interest rates by a quarter of a percentage point in March. The latest minutes of the Fed’s policy meeting show that the central bank could raise interest rates by half a percentage point on Wednesday and start reducing its portfolio of assets of $ 9 trillion. This may have surprised some in the market, who expect a less aggressive pace, Mr Griffiths said.
Ten-year government bond yields have been well above 3% for most of the last half century, exceeding 15% in the 1980s, according to Ryan ALM & Tradeweb ICE. But in the last decade, they have completed the day more than 3% only 64 times, reflecting a period that until recently was marked by slow growth and inflation.
While today’s bond yields remain low by historical standards, they still represent a remarkable turnaround from the early days of the Covid-19 pandemic, when 10-year yields fell by only 0.5%.
At the time, investors saw no reason to worry about rising interest rates. Not only was the economy in a precarious position, but Fed officials overestimated the way monetary policy was conducted, promising to be more cautious in raising interest rates after many years in which inflation remained largely below its 2% annual target.
Yields began to rise in late 2020 in response to the development of effective vaccines against Covid-19 and received another boost when Democrats gained full control of Congress, creating the ground for more fiscal stimulus.
However, the 10-year yield reached about 1.75% at the beginning of last year and spent much of 2021 in a gradual decline, even as inflation began to rise. Convinced by Fed officials that inflation is largely transient, investors expected an increase in interest rates in December by several quarters of a percentage point in 2022.
Since then, however, bonds have suffered blows as inflation remains persistently high and analysts continue to raise expectations of rising interest rates – raising the bar every time government bonds set prices in the most aggressive previous forecasts.
Interest rate derivatives are currently showing that investors expect the Fed to raise its reference rate on federal funds from its current level between 0.25% and 0.5% to just over 3% next year.
This implies a long way forward, in which many in the economy may be confused, including a further reduction in riskier assets such as stocks, forcing the Fed to halt its tightening efforts. The rise in yields has already led to sharply higher consumer borrowing costs – with 30-year mortgage rates rising above 5% – and contributed to the stock’s decline, which led to a 13% drop in the S&P 500 for the year.
However, many analysts believe that the interest rate on federal funds may need to rise well above 3% to curb inflation, which suggests that the sale of bonds may still have room for maneuver.
One point noted by such analysts is that inflation expectations are still rising over the next decade, even with the Fed expected to tighten. This means that the so-called real or inflation-adjusted government bond yields remain low even by recent historical standards, potentially providing an incentive for businesses to borrow and invest despite a sharp rise in nominal yields.
The yield on 10-year inflation-protected securities – a proxy for real yields – was about 0.16% on Monday afternoon, according to Tradeweb. This was up from minus 1.11% at the end of last year, but still well below the level of nearly 1.2%, which they reached at the end of 2018.
Write to Sam Goldfarb at sam.goldfarb@wsj.com and to Heather Gillers at heather.gillers@wsj.com
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