(Bloomberg) — Yields on U.S. debt blew past another set of closely watched levels, a warning sign for riskier assets that have benefited from exceptionally loose financial conditions amid the pandemic.
The 10-year U.S. real yield — which strips out inflation and is seen as a pure read on growth prospects — climbed 10 basis points to minus 0.69% on Thursday, surpassing a high of minus 0.75% set days after the U.S. presidential election in November. Nominal yields also soared, with the rate on 10-year Treasuries reaching 1.49%, the highest in a year. Its 30-year counterpart hit a similar milestone, climbing rapidly above 2.30%. And the 5-year yield exceeded 0.75%, an inflection point that is seen as potentially squelching global speculative euphoria.
It’s been a frenetic week for bonds globally, with yields climbing to levels last seen before the coronavirus spread worldwide. Central banks have attempted to soothe markets, with European Central Bank chief economist Philip Lane saying the institution can buy bonds flexibly and Federal Reserve Chairman Jerome Powell calling the recent run-up in bond yields “a statement of confidence” in the economic outlook. While higher real rates signal growth is gaining traction, investors are becoming uneasy over the sustainability of the recovery, and whether stimulus will feed into ever higher prices.
The 5-year note leading the rout “is a warning signal that the rates selloff is going beyond a repricing towards a convexity move,” said Peter Chatwell, a Mizuho International Plc strategist. “This is something which we think is inconsistent with Fed dovish rhetoric on rates.”
Convexity Hedging
Adding to the bond rout are forced sellers in the $7 trillion mortgage-backed bond market, who are likely unloading the long-maturity Treasury bonds they hold or adjusting derivatives positions to compensate for the unexpected jump in duration on their mortgage portfolios. It’s a phenomenon known as convexity hedging, and the extra selling has a history of exacerbating upward moves in Treasury yields — including during major “convexity events” in 1994 and 2003.
Convexity Hedging Haunts Markets Already Reeling From Bond Rout
Thursday’s selloff in Treasuries was led by the 5-year sector, a space of particular interest to many in the $21 trillion Treasuries market because the yield in that sector is around a level that could trigger more pain. Earlier this week, tepid demand in a $61 billion auction of five-year notes brought into focus this key part of the yield curve, which also reflects medium-term expectations for Fed policy.
In Europe, peripheral countries have led a sell-off in the region, with Italy’s 10-year yield spread over Germany climbing back above 100 basis points. Core debt wasn’t spared from the rout, with yields on France’s benchmark debt turning positive for the first time since June.
Clear Disquiet
Economic leaders the world over are making clear their disquiet. Apart from ECB’s Lane, Executive Board Member Isabel Schnabel weighed in, saying in an interview published Thursday that the central bank has a close eye on financial markets because a sudden rise in real rates could pull the rug out from under the economic recovery.
Powell Goes Easy on Surging Yields While Central Bank Peers Fret
Elsewhere, the Bank of Korea warned it will intervene in the market if borrowing costs jump, while Australia’s central bank resumed buying bonds to enforce its yield target. The Reserve Bank of New Zealand on Wednesday promised a prolonged period of stimulus even as the economic outlook there brightens. Emerging-market investors, meanwhile, are fixated on where short-end U.S. yields go, which could test market resilience there.
The latest leg of the bond selloff was rippling through equity markets. The S&P 500 Index fell 0.9% in New York morning trading.
“You have to look at real yields,” Christian Nolting, chief investment officer at Deutsche Bank Wealth Management, said in a Bloomberg Radio interview. “If real yields are really rising and rising fast, that in the past has always been an issue for stocks.”
(Adds 5-year yield, updates prices.)
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