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Surging U.S. Yields Show Stimulus Impact Still Getting Priced In

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Vivien Lou Chen, Stephen Spratt and Greg Ritchie
·3 min read
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(Bloomberg) -- U.S. Treasury yields rose to the highest since February 2020 and are at risk of climbing further, as investors start to factor in the full economic impact of a stimulus plan totaling as much as $1.9 trillion.

Rates on 10-year notes, a benchmark for global borrowing, eclipsed their peak from the March market pandemonium, reaching 1.31%. The selloff extended across developed-economy debt markets, gaining momentum as the U.S. House leadership laid out a plan to vote by month-end on President Joe Biden’s aid proposal.

The fixed-income losses are generating the worst start to a year since 2013 for a gauge of global bond performance. Investors are buying into signs the world’s economy is moving toward a recovery from pandemic-induced shutdowns, prompting asset managers to ditch bonds for stocks. The tumble in Treasuries could be about to accelerate, with strategists saying mortgage-related hedging may kick in if yields rise much higher.

“The move up in nominal yields, driven by real rates, suggests that upside risks to growth and supply -- given greater chances of a package as large as $1.9 trillion -- are getting priced in,” said TD Securities strategist Priya Misra. Moreover, “the move can continue for now because real rates are still near historic lows.”

The 10-year real yield -- which strips out inflation and is seen as a pure read on growth prospects -- climbed to minus 0.93%, the highest in about a month.

Tantrum Risk

For Misra, the selloff could get unruly, resulting in “a tantrum without the taper,” unless Federal Reserve Chairman Jerome Powell leans against the move in an appearance scheduled for next week. She was referring to the 2013 taper tantrum episode, in which former Chairman Ben Benanke’s hint of an early paring of bond purchases jolted yields sharply higher.

Investors also had rising energy prices on their radar. A key market proxy for 10-year inflation expectations reached the highest since 2014.

Amid the action in the U.S. session, the climb in 10-year yields was met by widening swap spreads -- as volatility hedging and hedging of mortgage-related positions appeared to be magnifying the Treasuries selloff. Hedging of mortgage bonds, often known as convexity hedging, could materialize if 10-year Treasury yields continue to rise past 1.30%, according to TD.

Read more: Taper Tantrum to VAR Shock: When the Next Bond Rout Is Coming

None of this is welcome news for those who bought into U.S. auctions last week. Investors snapped up a combined $68 billion of 10- and 30-year debt at yields more than 10 basis points lower than current levels. This week brings a $27 billion 20-year bond auction on Wednesday.

In the U.K., 30-year yields hit the highest level since March after the country hit a milestone in its vaccination program, supporting calls for easing of social restrictions. Germany’s benchmark yield climbed to levels last seen in June.

“There’s a great deal of optimism in the air and that’s one of the biggest reasons we’ve seen this rise in interest rates in the U.S. and globally,” said Tom di Galoma, managing director of government trading and strategy at Seaport Global Holdings. “We’re trading the likelihood that a large stimulus package is coming, the vaccination trend seems to be working in the U.S., and Europe is seeing a lot of positive signs on vaccinations and reopenings.”

Over the next two to three weeks, the 10-year yield should climb to around 1.36%, its 2016 closing low, he said. That’s one of the few meaningful technical levels left on the way to a 1.56% mid-year target, according to di Galoma. Meanwhile, he sees the 30-year yield rising to 2.15% during the same period, with a mid-year target of about 2.4%, a level last seen on a closing basis in 2019.

(Updates yields.)

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