- US government bond markets saw a steep sell-off and yields subsequently rose.
- The 10-year yield rallied as high as 1.30%, its highest since February 2020.
US government bond markets have undergone a steep sell-off on Monday and there has been a resultant steep rise in bond yields across the treasury curve. The 10-year bond yield is up more up nearly 10bps on the day and at one point eclipsed the 1.30% level for the first time since 27 February 2020. In other words, US government bond yields are at their highest since the week when the Covid-19 pandemic really “arrived” on the global stage to send global financial markets reeling and central banks like the Fed down a path of emergency policy easing. Tuesday’s move in government bond yields has underpinned the US dollar and seems to have weighed somewhat on equity market sentiment.
What happened on Tuesday?
Big moves in the US bond market on Tuesday suggest a shift in investor mindset. Before examining what that shift might be or what that shift might signal for other asset classes, it is worth examining exactly what happened in US government bond markets. As noted, bond yields have rallied, but importantly, the yield curve has steepened sharply; the difference between the 2-year yield and 10-year yield (often referred to as the 2s10s spread) rose more than 10bps on Tuesday to 119bps, the widest the gap has been since the back end of 2015. Note that this signals that while investors expect interest rates to remain very low over the next few years, hence why the 2-year yield is still at 0.121% (consistent with Fed guidance that rates will be kept are near-zero until at least 2023), investors are increasingly betting on higher interest rates further out.
Importantly, Tuesday’s move higher in US government bond yields has for the most part not been driven by expectations for higher inflation. That can be seen in the fact that real US bond yields have rallied by a similar amount to nominal bond yields; the 10-year TIPS yield is up over 7bps from last Friday’s closing levels and is around -0.94% (versus a near 10bps rally in the nominal 10-year yield), while the 30-year TIPS yield is up 6bps to -0.10% (versus an 8bps rally in the nominal 30-year yield). On the day, break-even inflation expectations (derived from the difference between real and nominal yields) are higher by a few bps and are at multi-year highs, but bets on inflation are not the main force driving today’s move higher in bond yields.
Implications for other asset classes
So what does all of this mean? A combination of factors; firstly, markets seem to be betting on a stronger economic recovery ahead, hence why inflation expectations have risen modestly. Secondly and most importantly, markets are betting on less accommodative monetary policy in the years ahead, hence the move higher in real yields. In fact, it almost seems as though markets are betting on some kind of sweet spot being found; markets are betting on a less accommodative Fed in the long run, but not so much so that this hurts economic growth (and inflation expectations).
In terms of what this means for other asset classes; if bond markets are right to bet on a less dovish Fed (perhaps a Fed that starts to taper its asset purchase programme earlier than expected, like the end of the year/start of 2022), then this will be a powerful positive for the US dollar.
In terms of what all of this means for equities; equities have been able to rally despite rising US government bond yields in recent years, but only as long as these yields still remain low by historical standards. That keeps the TINA (There Is No Alternative… to investing in equities, given the low yield in bonds) story alive. If the Fed can find a “sweet spot” as price action on Tuesday seems to be betting on (i.e. that when they do tighten, they do so in a methodical way that doesn’t hurt economic growth like during the last expansion), then this is unlikely to derail the equity market bull run.
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