Why not panic over the 10-year US Treasury yield hitting 1.7%

Americans like to say go big or go home.

But after a year of staying at home, investors began to worry about the possibility of losing money, or getting wrongly caught in their investments, if the U.S. government exceeds its support for the economy and causes an inflation hangover.

One of the reasons for the grimace was the sharp rise in benchmark government bond yields over seven weeks, with the 10-year Treasury TMUBMUSD10Y,
1.584%
rate at 1.729% on Friday, following a low of 0.51% a year ago.

“There are some rules of thumb,” Joe Ramos, head of US fixed income at Lazard Asset Management, said of financial markets. “First, the rate hike is bad.”

It is believed that if businesses pay more to borrow, they will pass the higher costs on to consumers by raising the prices of goods and services, which will cause households to spend more, but get less for their money. Any decline in spenders could hurt the economy’s recovery, even before it fully reopens after lockdowns imposed to tackle the coronavirus pandemic.

But Ramos also believes some old rules for financial markets have met their due date and should be scrapped, especially after yields on the US Treasury market fell by $ 21 trillion. the lowest records of last year.

U.S. Treasuries have long served as a reliable asset class for institutional investors looking for deflation protection, Ramos said, but he also called what drove Treasury yields so low. last year as a “sign of sickness” when it “looked like the world was going to fall apart on us.

The surge in yields in today’s environment comes as more Americans get vaccinated and Google searches Disney
DIS,
-0.22%
peak of holidays, signs of a return to health of the economy, according to Ramos. “One thing I tell people is that they are going to be able to afford more, even though it will cost more,” he said.

Powell patience

This idea depends on the ability of the United States to recover some 9.5 million jobs lost during the pandemic. Federal Reserve Chairman Jerome Powell said on Friday in an editorial that he plans to support the US economy “for as long as it takes”, but also said the outlook is improving.

Powell has drawn attention to the need for the central bank’s extraordinary measures to shore up financial markets amid the turmoil unleashed a year ago by escalating COVID-19 cases. A year later, the United States has taken a step ahead of Europe and other parts of the world in terms of vaccinations, leaving Wall Street to search for clues as to what is to come.

“The big picture is that why rates are going up really matters,” said Daniel Ahn, chief US economist at BNP Paribas. “It’s not just the levels, but the facts behind it, and the Fed has seemed quite optimistic about these upward moves, due to the improving outlook for the economy.”

Ahn also pointed out that LQD credit spreads,
+ 0.08%,
where premium investors are paid on top of T-bills to offset the risk of default on corporate debt, have not been significantly discounted, despite the rapid rise in yields on long-term US debt on about two months.

The US dollar DXY,
-0.20%
did not soar either, nor did the Dow Jones Industrial Average DJIA,
+ 0.19%
or S&P 500 SPX,
+ 0.08%
plunged into correction territory, even if the high-tech Nasdaq Composite COMP,
+ 0.09%
was under pressure. The three benchmarks booked a weekly loss Friday.

Perhaps another 70 basis point rise in the benchmark 10-year US Treasury yield over the next two months could be enough to trigger more market volatility. “But we haven’t seen that yet,” Ahn said.

Related: There will be no peace ” until 10-year Treasury yield hits 2%, strategist says

What? Expensive credit

He was 40 years since the US lending rate exceeded 20%, when former Fed Chairman Paul Volcker fought a lasting battle against soaring inflation.

Since then, generations of American homeowners have succeeded in 30 year fixed rate mortgage rate at 5% and they are now closer to 3%.

“Obviously, what inflation means differs for savers and Main Street from Wall Street,” said Nela Richardson, chief economist of ADP, adding that people still buy homes and take out home loans while mortgage rates were at 18% in the 1980s.

“Bond investors are more confident in an economy that requires higher yields to hold relatively safe assets,” said Richardson, but added that the markets tend to get nervous if higher yields end up meaning “the end of cheap money and practically free credit ”.

Billions of dollars of pandemic congressional fiscal stimulus slipping through the economy, just like more U.S. vaccinations potentially leading to a wider reopening of businesses this summer, could test inflation expectations.

“Since we haven’t seen inflation since Volcker, I think market participants are concerned that this will release it,” said Brian Kloss, global credit portfolio manager at Brandywine Global.

Kloss said that “basic industries, commodities and companies with pricing power” should do well for shareholders in an inflationary environment, but he also warned that in the coming weeks, after the Spring Break gatherings, the United States will have more clues as to the state of the COVID-19 threat.

If the United States can avoid a spike in new coronavirus cases, unlike in Europe where new lockdowns remain a threat, this “could be one of the first signs of a robust summer, as the looming season approaches. ‘fall,’ he said.

Meanwhile, the bond market already seems to be signaling that it has adhered to the Fed’s commitment to keep monetary policy accommodative for some time to come, said Robert Tipp, chief investment strategist at PGIM Fixed Income.

He pointed to the Treasury’s equilibrium rates which recently exceeded 2% as a signal that the bond market expects inflation to rise from emergency levels, on a break-even basis, an indicator of future price pressures based on US Treasury Inflation-Protected Securities (TIPS) trading levels.

But even as 10-year rates rise to 3% and inflation rises alongside the Fed’s new 6.9% GDP growth forecast for this year, Tripp expects both to fall back to levels. inferiors familiar over the past four decades.

After the 2008 global financial crisis, people predicted “Armageddon inflation” and that “the Fed could never get out of this policy” of quantitative easing, he said.

“But of course they did,” Tipp said.


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