The story in February has been inflation, inflation, inflation. The worries of rising inflation as central banks insist on accommodative policies until the labour market recovers significantly boosted yields upwards, putting stocks’ lofty levels in a new, riskier, light. Expectations of hefty stimulus this year also contributed to the cheapening in fixed income.
Hence the stocks and bond markets have been rattled by the rising inflation, leaving a less sanguine view of the policy outlook relative to what the central bankers are saying. Despite the assurances from the Fed this week that the heat up in inflation is not a threat to the low for longer policy pledge, Wall Street continues to be hammered as bond yields continue to soar.
More precisely, the yields spiked on the awful 7-year auction results today on month end. The 10-year rate surged and Bloomberg shows a 1.6085% high. The jump was brief (maybe a bad print) and the note has dipped back to 1.49%. Similarly, the long bond climbed to 2.39%, but has fallen back to 2.30%. The selloff in longer Treasuries has worked its way into the front end as well with the 2-year up 4 bps to 0.162%. A convexity trade and technicals have exacerbated much of the upshot in rates, while the Fed has attributed much of the rise in rates to improving confidence in the global recovery. The growing inflation worry is impacting too, even as Powell and Company try to jawbone it away, saying yields are rising for the “right” reason and that they are not too concerned over an outsized or sustained jump in price pressures. Fed George even said today the pop in yields does not warrant policy action. But as much as policymakers downplay the inflation threat, there should be some concerns inside the Fed. Be careful what you wish for.
But the key questions here are:
- Why should we care about inflation and yields?
- What happens when government bond yields slide?
- What factors affect yields?
- How can yields affect the overall market?
Treasury Yields: US 10-year Treasury Note
Treasury yields are the total amount of money investors earn by owning US Treasury bills, notes, bonds or inflation-protected securities. The government sells them to pay for the US debt. The rates vary depending on durations that form the yield curve. Treasury yields, especially the 10-year yields, are considered as a gauge of investor sentiment about the economic conditions.
It’s crucial to remember that yields go down when there is a lot of demand for bonds. Hence the price of bonds and yields have an inverse relationship. If the economy performs well, investors tend to buy riskier assets for better returns and they avoid investing in safe-haven assets. Hence, the price of Treasuries sinks while the yields rise. Contrarily, when investors’ confidence is shaken by a bad economy, they tend to buy Treasuries, pushing up their prices and causing the yields to drop.
Variables of US10Y Pricing
There are numerous factors that cause the US-10 year yields to rise or fall. All of these factors influence each other as well.
Interest Rates
Treasury yields are a concern for investors all over the world as they tend to serve as a primary benchmark from which all rates are conceived. These assets are considered the safest venues to invest in as they are backed by the resources and depth of the US government.
When the FOMC lowers the federal funds interest rates, it establishes additional demand for the US 10-year yields as they are able to lock the funds at a certain interest rate. Further added demand for Treasuries may lead to even lower interest rates.
Inflation
If the inflationary pressure rises in the US economy, the US10Y moves up because fixed income assets become low in demand. This additional inflationary pressure may urge the FOMC to increase the interest rates so the money supply shrinks. The inflationary environment may force investors to go for greater yields so that the diminished buying power can be compensated in the future.
Economic Growth
Stronger growth of economy mostly creates an increased aggregate demand that may eventually increase inflation if it persists over time. The competition for capital becomes high when the economy lies in a strong growth phase. Hence, investors may have many choices in how to generate higher returns. Resultantly, Treasury yields must gain to reach the equilibrium between demand and supply. For example, if the economy is progressing at 3% while stocks have a yield of 5%, investors will buy the Treasuries only if the yields are greater than that of stocks.
US 30-Year Bonds Yield
The US-30Y is the same as the US-10Y but with a different maturity period. Since the US-30Y shows a broader picture, it may be considered a leading factor whose pricing may affect the US-10Y. Hence, keeping a watch on the US-30Y can help to predict the price movement of the US-10Y due to their high positive correlation with each other.
The Bottom line
The US-10Y is not only a financial instrument but a measure of the economic outlook and investors’ confidence in the market. This is also considered as a parameter to find the global risk sentiment. The US 10-year yields and bond price are inversely proportional to each other. If the investors have higher appetite for risk, Treasury prices will decrease while yields will rise. Inflation, interest rate and economic growth are key factors that may influence price changes in the US-10Y.
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Adnan Rehman and Andria Pichidi
Market Analysts
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