In bond market era, investors see overdue correction

On weak days in the third quarter, yields on US government bonds rose. This can be taken as an encouraging sign about the economy’s prospects as yields, which rise when bond prices fall, typically climb with growth and inflation forecasts.

However, many analysts do not believe that yields are increasing now because so much has changed about the economic trajectory. Instead, they see the bond selloff as an overdue correction to an overdue rally — a product that is more profit-taking than a major change in thinking.

The reason yields rise matters because it can affect how investors react in other markets. All else being equal, high returns can hurt stock prices by incurring corporate borrowing costs and reducing the value of future earnings. But investors can also welcome them if they believe rising yields reflect a better growth outlook.

Investors have registered a mixed reaction in the matter. Most are optimistic about the economy, but their views haven’t changed much since last week, when yields were low. The stock has had its ups and downs, climbing first as yields began to rise, then declined sharply earlier this week.

Many investors are waiting for bonds to hit. After hitting a pandemic high of 1.749% on March 31, the 10-year yield fell to 1.173% on August 2 and was safely below 1.4% by the end of last week. But even in August, many believed yields were unnaturally low and bound to drop to higher levels.

“I don’t think there’s really anything fundamentally going on,” Blake Gwynne, head of US rate strategy at RBC Capital Markets, said on Aug. Some investors, he said, were buying bonds while they may still be aware that prices are likely to drop at some point, but believe they will not in the near future. Others with long short positions were inclined to sell, but were skittish after being burned by the rally.

Mr Gwyn had anticipated that the momentum would really change only after the September 21-22 meeting of the Federal Reserve. He added that before resetting their positions, investors were almost waiting for a meeting when the Fed would likely take a “tangible turn” to tighten monetary policy.

Seven weeks later, more or less this is what happened. On September 22, the Fed indicated that it would begin to scale back its purchases of Treasury and mortgage-backed securities as soon as November. Officials also indicated that they may raise short-term interest rates sooner and faster than previously thought.

Neither growth was a surprise to investors, and yields changed little just after the meeting. The next day, however, investors began dumping Treasuries, pushing the 10-year yield back to 1.540% as of Wednesday.

As the sale began on September 23, Mark Lindbloom, a fixed income portfolio manager at Western Asset, said people like him were running it. On that day, Mr. Lindbloom’s team returned bets on the long-term Treasury’s outperformance. “Our portfolio position has benefited our clients,” he said, but it was time “to remove some of that, just to hedge our bets a little bit.”

Many analysts still attribute at least some of the recent increase in yields to the actually improving economic outlook.

There have been some disappointing economic data in recent months, including a retail sales report in August that was much lower than expected. In September, however, the same report covering sales in August was much more encouraging – suggesting that the economy was facing a surge in Covid-19 cases driven by the highly contagious delta variant. Signs that the delta wave may be peaking in the US, investors expect more workers to return to their offices, for added economic benefits, said Thanos Bardas, global co-head of Investment Grade and senior portfolio manager at Neuberger Berman. .

There may be a limit to how high yields can climb from here. Several analysts have predicted in recent months that the 10-year yield could reach 1.75%, or 2%, by the end of the year. But his forecasts for yields beyond that point are constrained by longer-term trends.

Most important, even long-term Treasury yields are typically determined by expectations of short-term interest rates set by the Fed. But in recent decades, the central bank has been leaving its benchmark federal-funds rate progressively lower due to a variety of factors, possibly including a potential slowdown in economic growth, analysts said.

As it stands, the so-called neutral interest rate that neither stimulates nor slows the economy could be slightly below 2%, analysts at Cornerstone Macro estimated in a recent report. This suggests that it would be difficult for the central bank to raise rates above that threshold, thereby imposing some soft caps on Treasury yields.

While investors can sometimes anticipate that the Fed may raise rates above neutral levels, “it is much harder, mathematically, to contemplate, say, a 3% 10-year Treasury yield when the nominal neutral rate is 2%.” less than,” he wrote.

This story has been published without modification to the text from a wire agency feed