The continued rise in U.S. bond yields was on the horizon on Monday ahead of Federal Reserve Chairman Colin Powell’s congressional testimony next week, and traders will be watching for signs that he is unsettled by rising long-term borrowing costs.
The 10-year US Treasury yield rose almost 4 basis points to 1.3822 per cent in the Asian session, a one-year high. Meanwhile, the yield on the US 30-year Treasury rose 3.6 basis points to 2.176 per cent, its highest level since January last year.
Separately, the spread between US two-year and 10-year Treasury yields widened to 126.8 basis points, the widest since early 2017.
Since yields on the benchmark 10-year Treasury note hit a low of 50 basis points in August, they have risen across the board.
Treasury yields and inflation expectations have continued to rise as the US continues to make progress on vaccination, the economy continues to open up and the prospect of further fiscal stimulus.
The stock market’s reaction to the sharp rise in Treasury yields was only wobbly. But some investors worry that a sustained rise in Treasury yields could make relatively risky assets such as stocks less attractive.
“When government bond yields go up, all assets should be repriced, that’s the rule,” says Eric Friedman, chief investment officer at Bank of America Wealth Management. “But I don’t think yields have risen enough to compete with equities.”
Analysts at Nomura said earlier this week that if the 10-year Treasury yield rose above 1.5%, it could send stocks down 8%.
Bank of America strategists said the rapid rise in bond yields over the past week has spooked some investors, but it would take nearly half a percentage point more for yields to rise to meet more resistance. The yield level, which could trigger a shakeout, was 1.75%, still well above the current level of around 1.35%.
If long-term borrowing costs soar, tightening financial conditions or triggering illiquidity, the Fed will almost certainly step in, either by increasing asset purchases or by imposing yield curve controls. So far, however, the Fed has shown few signs of concern. New York Federal Reserve Bank President John Williams said recently that the rise in yields was a sign of optimism about the economic recovery. Others agree.
‘We’ll continue to see volatility around inflation expectations and actual inflation,’ said Chris McReynolds, head of U.S. Treasury trading at Barclays in New York. But you have to take the Fed at its word that they will be behind the yield curve in tightening policy even as the economy and inflation pick up.
Looking ahead to this week, the market will focus on Fed Chairman Colin Powell’s speech. He spoke about the economic outlook at Senate and House hearings on Tuesday and Wednesday.
Mr Powell will have two days to field questions about the Fed’s dovish approach and when the rise in Treasury yields poses a risk to the economic recovery.
Beyond that, markets will be looking for any indication that the Fed is about to exit QE, but are unlikely to find any. Powell insists it is too early to talk about that. If anything, he will reiterate the need for accommodative policy and encourage Congress to “step up” on spending plans. For the markets, this will be old news.
The risk is that if the economy is strong and Powell is lax on Fed normalization, that could be over-interpreted by investors and trigger a temporary bout of risk aversion.
Mark Cabana, head of US interest rate strategy at Bank of America in New York, said markets expect Powell to reiterate that economic data have improved, the epidemic has improved, but that the Fed’s easy money policy will remain in place for an extended period of time until the economy has improved. The claim may not be overtly dovish, but it is expected to be stimulating enough.
Mark Zandi, chief economist at Moody’s Analytics, said Powell’s comments were unlikely to deviate from the framework and support for U.S. President Joe Biden’s $1.9 trillion bailout plan.