US Government Bond Yields Reach 16-Year High, Sparking Market Sell-Off
Investors are facing a major sell-off in US government bonds as the outlook for higher interest rates lingers. The yield on the 10-year Treasury, which is considered a key benchmark, has reached its highest level in 16 years, hitting close to 5%. This surge has triggered panic in the market and is ranked among one of the worst crashes in market history.
Despite the turmoil in the markets, experts suggest that the current yields are in line with expectations for the economy over the medium-term. Christoph Schon, senior principal of applied research at market data firm Qontigo, explains that a 10-year yield of 4.7%-5.1% seems appropriate given the current long-term inflation expectations, which stand at around 2.45%. Schon refers to previous decades when the 10-year Treasury yield was roughly double the inflation expectations. This meant that investors could expect real returns that matched the expected rate of inflation.
However, the dot-com bubble and the 2008 financial crisis caused a shift in this relationship. Treasury bonds became a safe haven asset for investors during periods of volatility in the stock market. Now, with the recent surge in consumer prices and rising global tensions such as Russia’s invasion of Ukraine, stocks and bonds are once again correlated. This has caused both assets to sell off together as interest rates rise.
Schon argues that the current environment is more akin to the pre-2000s, where Treasury bonds were attractive alternatives to equities, rather than just safe havens during times of turmoil. Based on historical trends, he suggests that investors would be looking for yields between 1.9 and 2.1 times inflation expectations. With the current 10-year breakeven rate at 2.45%, this implies a corresponding nominal yield of 4.7% to 5.1%.
Looking ahead, Schon believes that the probability of the 10-year Treasury yield climbing above 5.5% is less than 1%, unless there is a significant revision higher in inflation expectations. Federal Reserve (Fed) Chief Jerome Powell also acknowledged the bond market volatility and stated that rising yields have helped tighten financial conditions. The market currently shows a 98% probability of no rate hike at the Fed’s November 1 meeting, with a 24% chance of a 25 basis point hike in December.
Nevertheless, other strategists caution that there is still a possibility of even higher yields. Phillip Colmar, global strategist at MRB Partners, predicts that yields could breach 5.5% in 2024. Additionally, Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors, highlights the potential for a government shutdown in November, which could further push yields higher.
Barclays strategists also weighed in on the situation, noting that the 10-year yield is still below the expected terminal rate for the current hiking cycle by the Federal Reserve. This contrasts with how tightening cycles typically end. They emphasize that despite the economy showing resilience, there is a consensus expectation of a sharp slowdown in the coming quarters. The repeated misses in economic data raise questions about whether the consensus has been too confident about monetary policy being too tight. The strategists suggest that policy is still relatively loose and the risks lean towards continued upside surprises.
The future of bond yields remains uncertain, but the recent climb to a 16-year high has certainly triggered market upheaval and raised concerns among investors. As the Federal Reserve monitors the situation, market participants will be watching closely for any further developments that could impact these critical interest rates.
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