What does the very rapid recovery in 10-year U.S. bond yields mean for the market at the moment?
According to Barron’s, a U.S. financial media outlet, long-term Treasury yields are growing much faster than short-term Treasury yields, indicating that investors are betting that the U.S. economic recovery will accelerate further.
The steepness (or flatness) of the yield curve is often seen as an indicator of economic growth.
When the curve “reverses” or when long-term yields are lower than short-term yields, economists usually think that this could be a recession warning.
Now the curve is getting steeper, which indicates that investors expect U.S. economic growth and Inflation to strengthen in the coming decades.
Long- and short-term U.S. bond spreads widen
Since August, the yield on the 30-year U.S. Treasury note has climbed 73 basis points to 1.92 percent. The yield on the 20-year Treasury note has climbed 77 basis points to 0.96 percent, and the yield on the 10-year Treasury note has climbed 63 basis points to 1.15 percent. The rise in yields on these long-term U.S. Treasuries was more pronounced than the gains on short-term Treasuries.
In addition, one of the most popular U.S. bond indicators is the gap between the 2-year and 10-year Treasury yields, which is now at its maximum since 2017.
In addition, the yield differential between the 5-year U.S. bond and the 30-year U.S. bond has reached its highest level since 2015.
Wall Street strategists expect this trend to continue for one simple reason: U.S. economic growth expectations.
Barron’s believes that while all U.S. Treasury yields reflect future interest rate expectations and inflation risks, the long-term performance of the stock market is more sensitive to rising interest rates and bond yields, and its value is more vulnerable to inflationary erosion.
As a result, investors are placing higher expectations on growth and inflation as the U.S. economy reopens, vaccines become widely available and government stimulus measures are discussed.
Will the Fed withdraw easing soon?
Nevertheless, the market generally expects the Fed will not start tightening policy soon.
Deutsche Bank believes that the Fed may not start tapering quantitative easing until mid-2022, and interest rate hikes will have to wait until at least 2023.
As the Fed’s way of dealing with inflation has changed, even after economic growth and inflation recovery, the Fed may also take a cautious and slow exit from easing in the coming years, which may be the reason why 5-year Treasury yields are still low.
What is the impact of higher U.S. bond yields on the market?
Higher long-term interest rates and a widening gap between short-term and long-term yields have had a number of implications for markets and investors.
First, a steady rise in yields may help prevent a sell-off in long-term Treasuries like the one that occurred in 2013.
Strategists at Deutsche Bank predict that the Fed will begin discussing reducing the pace of its bond purchases this year, but will not begin tapering until mid-2022. In a report earlier this week, they noted that investors are already much more bullish on U.S. Treasuries than they were in 2013, making a sharp destabilizing reversal less likely.
Second, bank stocks are likely to continue to perform strongly.
When the yield curve steepens, banks’ net interest yields will improve because they typically borrow short-term and lend long-term. The S&P 500 Bank ETF has risen nearly 11% so far this year.
However, for U.S. stocks as a whole, high yields could have an impact on stock valuations. However, on another level, the economic recovery that is driving yields up will also drive corporate earnings growth.
Third, Treasury yields will eventually climb enough to attract investors back into the market.
The consensus on Wall Street is that the 10-year Treasury yield will climb to about 1.5% by mid-year. Although this is well below the average level of Treasury yields seen by investors over the past few decades, it is still a significant improvement over last August’s low of 0.5%.
Recent Comments