A sell-off has pushed US Treasury bond yields closer to their March highs, confirming predictions that a long summer rally would fade amid persistent inflation and an impending turn to tighter monetary policy.
Yields, which rise when bond prices fall, have been on a sharp uptrend since the Federal Reserve’s September 21-22 policy meeting. On Friday, a disappointing job report from September temporarily halted the increase. But the yield on the 10-year note ended the session at 1.604%, its highest closing price since June.
While the surge was abrupt, it was long awaited by those on Wall Street who spent the summer arguing that yields were lower than they should be. Investors pay special attention to government bond yields, in part because they serve as a benchmark for interest rates across the economy. They are also an important economic indicator that reflects expectations about the level of interest rates set by the Fed, which are themselves dictated by growth and inflation forecasts.
Part of the rally that dragged the 10-year yield down from its recent high of 1.749% in March appeared to reflect lower growth expectations. However, many of the purchases appeared to analysts as either tactical or opportunistic and should end in the fall as trading activity picked up and the Fed got closer to the first step in its tightening policy: reducing its monthly bond purchase program by $ 120 billion.
The Fed was more or less in line with expectations and at its meeting in September signaled emphatically that it could curb its bond purchases as early as November. Officials also said they could raise short-term interest rates above their current near-zero levels as early as next year.
In the weeks that followed, investors reacted by selling all types of government bonds, causing ripples in the markets, including dollar gains and declines in technology stocks.
Short-term bond yields, which are particularly sensitive to the Fed’s interest rate outlook, have risen. But they have also gained in longer-term bonds, suggesting that investors believe the Fed can keep rate hikes even after its first move.
Other factors contributed to the sell-off, according to analysts. A drop in new Covid-19 cases has renewed hope that more workers could soon return to their offices, which will boost the economy. A deal in Congress to extend the US debt ceiling into December has removed a short-term economic threat. Meanwhile, persistent supply shortages, soaring energy prices and strong consumer spending have raised inflation expectations.
The prospect of tapering is a major driver of the rise in returns, but another is inflation, which “may have some legs,” said Larry Milstein, director of government and agency trading at RW Pressprich & Co.
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Friday’s job data changed these calculations little. Prior to the report, some analysts thought the Fed might reconsider its throttling schedule if the economy created fewer than 200,000 jobs in September. As it turned out, actual employment gains remained just below that threshold. But the upward revisions of the previous months still left traders confident that the Fed would stick to its plans.
Many investors and analysts believe that government bond yields can continue to rise from here. Some have long predicted that the 10-year yield would end the year at 2% and stuck with that forecast even though it fell to just 1.173% in August.
Others warn that investors may underestimate future economic risks, including the possibility that rising energy costs and supply shortages will weigh on growth.
“Look at the trends over the past two months, and maybe the markets view of 2022 makes sense,” wrote Jim Vogel, interest rate strategist at FHN Financial, in a Friday message to clients. “Look ahead to the next four months and the chances of a sustainable GDP recovery are already diminishing.”
Write to Sam Goldfarb at email@example.com
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