On a day devoid of major market-moving news, investors pushed yields in the roughly $25 trillion Treasury market closer to or further above 5% on Wednesday.
It’s not so much the level of yields that could prove problematic, analysts say, but the speed with which they got there, with the pace only accelerating since the Federal Reserve’s policy announcement last Wednesday.
Three years ago, at the start of the H1N1 pandemic in the US, yields on everything from Treasury bills to the 10-year Treasury note were close to zero. But in just the past few months, rates on 2-year, 10-year and 30-year Treasuries have all jumped more than a full percentage point from their 2023 lows.
One of the biggest factors pushing long-term Treasury yields to multi-year highs is a recalculation of what’s known as the term premium, or the compensation investors demand for the risk of holding a bond for the life of the security, says Alex Pelle, an economist at Mizuho Securities in New York. Unlike the risk of holding cash, which is seen as limited, the same can’t necessarily be said for long-term government debt.
“What are the components of long-term yields? The market’s assessment of the long-term point or level that Fed officials think is appropriate for their key interest rate target, and some term premium because investors want compensation for duration risk,” Pelle said by phone on Wednesday. “One of the things that’s happening here is a repricing of the term premium, given the high budget deficit and the large amount of supply that’s coming online.”
The move towards 5% Treasury yields “is not all bad if it’s an endorsement of the structurally higher growth environment we’re in, where the economy is fundamentally more resilient than in the past,” he said. “But the other part of it is more negative, with investors worried about the trajectory of government debt and a huge deficit, as well as the Fed’s quantitative tightening efforts.”
The speed of the current sell-off in US government debt is raising the possibility of renewed trouble for banks and other existing holders of Treasurys, which tend to be hit hardest by rising yields. TD Securities strategists Gennadiy Goldberg and Molly McGown said a prolonged sell-off in bonds “increases the risk of ‘breaks’ similar to those seen during last year’s liability-driven investment crisis in the UK and this year’s collapse of Silicon Valley Bank”.
Global insurers surveyed by BlackRock Inc. BLK, -0.51% before the recent spike in market-implied rates cited the potential for more cracks in banks as their biggest concern. And in a note on what it would take for the 10-year rate to reach 5% in the near term, BofA Securities strategist Bruno Braizinha said “we continue to recommend hedging scenarios where yields continue to push higher.”
Wednesday’s sell-off in Treasurys began just before midday in New York, reversing the buying seen earlier in the morning. The 10-year BX:TMUBMUSD10Y and 30-year BX:TMUBMUSD30Y yields jumped to 4.625% and 4.731% respectively, closing at their highest levels since 16 October 2007 and 10 February 2011. There were also big jumps in 3-year and 20-year yields, which both rose to 4.9%.
“We are seeing a re-steepening of the curve with many yields going higher, including 3-, 5-, 7- and 10-year rates,” said Mizuho’s Pelle. “But is anything going to break? Certainly there are people who are going to lose money. The speed of these moves is hurting investors who were long duration. We’re moving rates higher on a day when nothing else is happening. There’s an asymmetry in these market moves as investors reassess the yield levels at which they’re willing to buy long-term government debt”.
