Why You Shouldn’t Freak Out Because the Yield on 10-Year US Treasuries Hit 1.7%


Americans like to say: go big or go home.

But after a year of staying home, investors have begun to worry about losing money, or being caught on the wrong foot in their investments, if the United States government oversteps its support for the economy and provokes an inflationary hangover.

One reason for the contraction has been the strong seven-week rally in benchmark government bond yields, with the 10-year Treasury TMUBMUSD10Y,
1,726%
rate at 1.729% on Friday, from a year-ago low of 0.51%.

“There are certain rules of thumb,” Joe Ramos, Lazard Asset Management’s director of US fixed income, said of financial markets. “One is that raising rates is bad.”

The idea is that if businesses pay more to borrow, they will pass the rising costs on to consumers by increasing the prices of goods and services, causing households to spend more, but get less for their money. Any pullback from spenders could hurt the recovering economy, even before it fully reopens from the lockdowns imposed to combat the coronavirus pandemic.

But Ramos also believes that some old rules for financial markets have reached their expiration date and should be withdrawn, particularly after yields on the $ 21 trillion US government Treasury bond market fell to record lows of the previous year. last year.

US Treasuries have long served as a reliable asset class for institutional investors seeking protection against deflation, Ramos said, but he also rated what made Treasury yields so low. last year was a “sign of sickness”, when to collapse on us “.

Rising yields in today’s environment come as more Americans get vaccinated and Google searches for Disney DIS,
-0.59%
Holidays are increasing, signs that the economy is returning to health, according to Ramos. “One thing I tell people is that they will be able to pay more, even if it costs more,” he said.

Powell’s patience

This idea hinges on the ability of the United States to recover some 9.5 million jobs lost during the pandemic. Federal Reserve Chairman Jerome Powell said in an op-ed on Friday that he plans to support the US economy “for as long as it takes,” but also said the outlook has improved.

Powell drew attention to the need for extraordinary steps by the central bank to shore up financial markets amid the turmoil unleashed a year ago by escalating COVID-19 cases. A year later, the United States has been ahead of Europe and other parts of the world in terms of vaccinations, leaving Wall Street looking for clues about what will come next.

“The big picture is that it really matters why rates are going up,” said Daniel Ahn, chief US economist at BNP Paribas. “It’s not just about the levels, but the facts behind it, and the Fed has been quite optimistic about these upward moves, given the improving outlook for the economy.”

Ahn also noted that LQD credit spreads,
+ 0.15%,
o The premium paid to investors above Treasuries to offset corporate debt default risks has not been significantly reduced, despite the rapid rise in long-term U.S. debt yields over approximately two months.

The US dollar DXY,
-0.13%
neither has it skyrocketed dramatically, nor has the Dow Jones Industrial Average DJIA,
-0.71%
or S&P 500 SPX,
-0.06%
sunk into correction territory, despite the high-tech Nasdaq Composite COMP
+ 0.76%
has been under pressure. All three benchmarks posted a weekly loss on Friday.

Perhaps another 70 basis point increase in the benchmark yield on 10-year US Treasuries over the next two months could be enough to trigger further market volatility. “But we haven’t seen it yet,” Ahn said.

Related: There will be no peace ‘until 10-year Treasury yield hits 2%, says strategist

What? Expensive credit

It has been 40 years since the US prime rate exceeded 20%, when former Fed Chairman Paul Volcker waged an enduring battle against rampant inflation.

Since then, generations of American homeowners have been able to raise 30-year fixed-rate mortgage rates to 5% and now they are closer to 3%.

“Obviously what inflation means is different for savers and Main Street than Wall Street,” said Nela Richardson, ADP’s chief economist, adding that people were still buying houses and borrowing home when mortgage rates were at 18. % in the 1980s.

“Bond investors are more confident in an economy that requires higher yields to keep assets relatively safe,” Richardson said, but added that markets tend to get nervous if higher yields end up spelling “the end of cheap money and practically free credit. “

Trillions of dollars in pandemic congressional fiscal stimulus running through the economy, just as more vaccines in the US potentially lead to a broader reopening of businesses this summer, could test inflation expectations.

“Because we haven’t seen inflation since Volcker, I think market participants are concerned that this could trigger it,” said Brian Kloss, global credit portfolio manager for Brandywine Global.

Kloss said that “basic industries, commodities, and companies that have pricing power” should do well for shareholders in an inflationary environment, but he also warned that in the coming weeks after spring break meetings , The US will have more clues about the status of the COVID-19 threat.

If the US can avoid an increase in new coronavirus cases, unlike Europe, where additional closures remain a threat, “it could be one of the first signs of a strong summer heading into fall,” He said.

Meanwhile, the bond market already seems to indicate that it has accepted the Fed’s commitment to maintain accommodative monetary policy for some time, said Robert Tipp, chief investment strategist at PGIM Fixed Income.

He pointed to equilibrium Treasury rates that recently surpassed 2% as a sign that the bond market expects inflation to rise from emergency levels, based on breakeven points, an indicator of future price pressures based on US Treasury Inflation Trading Levels Protected Securities (TIPS).

But even if 10-year rates rise back to 3% and inflation rises alongside the Fed’s new 6.9% GDP growth forecast for this year, Tripp expects both to fall back to lower levels. family lows during the last four decades.

After the 2008 global financial crisis, people were predicting “inflation Armageddon” and that “the Fed could never get out of that policy” of quantitative easing, he said.

“But of course it does,” Tipp said.

Next week will bring a flood of US economic data. Monday and Tuesday will see the launch of new and existing home sales for February. Wednesday brings durable goods orders for February, as well as preliminary updates to the manufacturing and services sector index for March.

Thursday’s weekly jobless claims data and the final fourth-quarter GDP estimate, while Friday will show the latest data on personal income, consumer spending, core inflation for February and the latest reading of the index of consumer confidence.

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