Investors are waking up to the risk of a decline in long-term us government bond prices, in anticipation of a more robust economic recovery and hefty additional government spending after novembers presidential election.
The $20tn treasuries market had grown sleepy in the months since the federal reserve slashed policy rates to zero to tackle the financial effects of coronavirus.expected volatility, as measured by the ice bofa move index, hovered around record lows, and the benchmark 10-year treasury yield barely budged from about 0.6 per cent, aside from a brief spike in june.
But treasuries have broken free from that slumber in recent days, with long-dated treasury yields rising sharply since the start of the month to their highest levels since june. a handful of fund managers warn this may be the start of a much sharper sell-off in us government debt, with the benchmark 10-year note potentially flirting with levels last seen before the coronavirus outbreak tore through financial markets.
If you look at where 10-year yields were going into the crisis, they were close to 2 per cent. there is no reason why we can't get back there in a matter of months, said zachary squire, chief investment officer at hedge fund tekmerion capital management.
The us economy has recovered more quickly than many believed it would, mr squire said, and monetary and fiscal policymakers have co-ordinated efforts to an unprecedented degree. that raises the chance of a pick-up in inflation and points to a rise in economic growth, sapping demand for the safety of government bonds. you are going to have a bounceback in the third quarter, he said.
The magnitude of the potential move hinges on the results of the presidential election, investors said. the republicans are likely to push for more spending after the november 3 vote, but a triumph for democratic candidate joe biden and dual victories in both chambers of congress for his party would probably pave the clearest path towards a more ambitious stimulus programme.
All of the recent proposals put forward by democratic legislators in the latest negotiations before current republican president donald trump abruptly called them off on tuesday have dwarfed what republicans have been willing to put on the table.
The whole [recent] spike in rates is the realisation that the chance of a democratic sweep has increased, said thanos bardas, global co-head of investment grade fixed income at neuberger berman, adding that he expected 10-year treasury yields to eventually climb above 1 per cent within 12 months.
Mr biden is leading in national polls, and the chance that democrats will gain control of the senate has also increased. modelling by fivethirtyeight, the poll tracking website, suggests that democrats have a 68 per cent chance of winning a majority in the senate, up from 61 per cent last week.
If democratic policymakers open the spending spigots and a vaccine emerges to control the global coronavirus outbreak, investors may pull forward their expectations for us interest rate rises. rather than in 2025, as is anticipated now, lift-off could come as early as 2023, said praveen korapaty, chief global rates strategist at goldman sachs.
Strategists at morgan stanley are even beginning to worry about a rates scare a sudden move higher in government bond yields that could take the market by surprise, with big implications for us stocks.
The big barrier to that is the fed. a rapid decline in bond prices is likely to prompt a swift response from the us central bank. having unleashed a torrent of liquidity to ensure financial conditions remain loose, the fed is likely to show little tolerance for a destabilising increase in rates that upends efforts to support the economy.
Some have already called on the central bank to alter its monthly $80bn treasury bond-buying programme and focus the bulk of its purchases on longer-dated debt. strategists at td securities reckon the fed may be forced to act as early as december.
The market is testing the fed, said priya misra, global head of rates strategy at the canadian bank. no action could trigger a much bigger move higher in yields if coupled with optimism around a vaccine or much more fiscal stimulus after the election.
Still, investors and analysts say the risk is worth monitoring closely. a lurch higher in treasury yields would hit the growth stocks that have led the stock market rally since march, according to michael wilson, an equity strategist for morgan stanley, in part because the value of their future cash flows would be reduced as inflation picks up.
The winners in this scenario are expected to be value stocks which are judged to be cheap in relation to their profits or assets and cyclical companies that benefit most from an improving economy, such as banks.
The increase in yields will prove to be very important for capital markets overall and leadership in the equity markets specifically, mr wilson said.