Treasury 10-year yields rose above 4.5% for the first time since 2007 as a more hawkish Federal Reserve adds to concern the bonds face a toxic mix of large US fiscal deficits and persistent inflation.
US government debt is headed for a third year of losses as bets on a rapid Fed pivot from aggressive interest rate hikes evaporate again after the central bank on Wednesday raised its projections for future borrowing costs.
The resilience of the US economy in the face of the steepest rate increases for a generation is spurring a flight from bonds, given the likelihood of a soft landing that would rule out rapid policy easing in the coming year. Surging oil prices and a massive fiscal deficit also have traders bracing for further selloffs after this week’s rout sent yields on every benchmark Treasury maturity to the highest levels in more than a decade.
“The soft-landing scenario now being priced into markets is why we have seen a big repricing of the back end,” said Kellie Wood, a fund manager at Schroders Plc in Sydney, who has been shorting 10- and 30-year Treasuries. “The 10-year yield isn’t offering enough reward given the longer-term risks posed as investors come to the realization that deficits are so large at a time when the economy is operating at, or beyond, full employment.”
That economic outlook brings with it the risk the Fed will again confound investors by extending rate hikes, a prospect raised this week by JPMorgan Chase & Co. chief executive officer Jamie Dimon.
The US 10-year yield rose about one basis point to 4.5064% on Friday in Asia trading, before moving back down to 4.49%.
Bill Ackman says he remains short bonds because he expects long-term rates to rise further. The yield on 30-year debt climbed as much as one basis point Friday to 4.59%, adding to the 13 basis-point jump on Thursday that took it to the highest since 2011.
“The long-term inflation rate plus the real rate of interest plus term premium suggests that 5.5% is an appropriate yield for 30-year Treasurys,” Ackman, the billionaire founder of Pershing Square Capital Management, posted on X, formerly known as Twitter.
What Bloomberg Strategists Say...
“Bond yields are no longer about how many hikes remain in the tank, but rather how many cuts we’re going to get for the foreseeable future. And there, messaging from the likes of the Fed was decidedly less than friendly,” Cameron Crise, macro strategist.
A Bloomberg index shows the Treasury market has fallen 1.2% this year, after it peaked in April when it was up by more than 4%. This follows declines of more than 12% and over 2% in the preceding two years. A separate gauge of global bonds is also at its lows of the year.
The surge in benchmark rates is spreading pain across asset classes, with US stocks suffering the biggest drop in six months on Thursday as investors recalibrated for a world where rates sit at levels not seen since before the Global Financial Crisis.
That’s a far cry from the optimism with which fixed-income investors started 2023, which was then seen as likely to be the “year of the bond” with higher yields restoring their haven allure.
But, instead of acting as havens, bonds have spent much of the year as a source of volatility for global markets. Rallies in the earlier months of 2023 have given way to steep losses.
The pain isn’t over for bonds even if the Fed stops raising rates, according to Bill Gross, former chief investment officer at Pacific Investment Management Co. The central bank is set to refrain from further hikes, but sticky inflation and widening deficits will drive losses, he wrote in an investment outlook published this week.
This was the result of government fiscal spending that equates to throwing “money out of a helicopter,” Gross wrote in the outlook penned before the Fed’s meeting.
The Congressional Budget Office in May predicted the budget deficit will total $20 trillion over the coming decade, with federal debt held by the public reaching 119% of gross domestic product, the highest in US history.
Nomura Inc. is skeptical yields can go much higher.
“We’ve been surprised by the magnitude of the selloff,” said Andrew Ticehurst, a rates strategist for Nomura in Sydney. The move looks large even given continuing growth and the Fed’s “higher for longer” narrative, he said.
The Fed’s so-called dot plot of projections shows policymakers plan to raise their target rate again by year’s end to a range of 5.5% to 5.75%. That would mean a total increase of 125 basis points for 2023, whereas swaps traders at the end of last year were pricing in one more increase at most.
Traders now see the Fed funds rate ending 2024 at about 4.75% after it peaks near 5.5%.
“Investors should prepare for a reversion to the ‘old normal’ of higher rates — which was the long-term norm before the exceptionally loose policies that followed the global financial crisis and the pandemic,” Sonal Desai, fixed income chief investment officer at Franklin Templeton, wrote in a note.
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