U.S. Treasury yields jumped Monday following the Senate’s approval of the $1.9 trillion Covid-19 relief bill over the weekend, which moves President Biden’s key spending package closer to being signed into law.
The huge stimulus, which faces a final vote in the House as early as Tuesday, is expected to boost the U.S. economy just as vaccinations allow more businesses to reopen, driving a burst of activity and a likely pickup in inflation.
The 10-year yield briefly rose as high as 1.610% on Monday morning, surpassing the 1.609% hit when Treasurys sold off sharply on Feb. 25, according to Tradeweb, before dropping back to 1.598%. Bond yields rise when prices fall.
The rise in yields is also putting pressure on growth stocks, such as technology companies, whose valuations are linked to prevailing discount rates for long-term cashflows. The Nasdaq-100 dipped 1.7% in futures markets Monday morning.
The Federal Reserve has been sanguine in its response to rising yields because it sees them as a sign of the brightening outlook for the economy. It also now targets an average inflation rate over time, which means the central bank would allow inflation to run above its 2% target for a spell before tightening monetary policy.
Investors are having trouble adjusting to this new policy framework. There is confusion about where yields will settle and some skepticism that the Fed will stick to its low rates and bond-buying program.
“The market still hasn’t completely absorbed the idea of the average inflation targeting regime,” said
senior macro strategist at Nordea Asset Management. He also pointed to the strong jobs report on Friday and a test for the market with a big auction of new 10-year Treasurys coming up on Wednesday. He expects 10-year yields to move toward 1.8%.
A rise in real yields—or the yields on inflation-protected Treasurys, known as TIPS—is potentially more important in judging how and when the Fed might change its policy. These haven’t risen as much as normal yields and the gap between the two has grown, which indicates higher inflation expectations.
On Monday, 10-year inflation expectations hit 2.24%, the highest since the summer of 2014. Shorter-term inflation expectations have risen even faster, with the five-year measure exceeding 2.55% Monday.
This suggests expectations that a rise in inflation will be followed by the Fed taking action and bringing inflation back toward the target over the longer term. However, if real yields start to rise faster, especially at shorter maturities, that would suggest market skepticism over Fed policy, according to Neil Shearing, group chief economist at Capital Economics.
That “might indicate that the markets do not believe the Fed’s commitment to keeping its policy rate at near-zero until it has achieved a ‘broad and inclusive’ recovery,” Mr. Shearing said.
The difference between real yields on five-year and 10-year TIPS, which measures the steepness of the curve, has been rising steadily since last April and has reached almost 1.1 percentage points. That is the steepest the curve has been since April 2014. However, it hasn’t changed for three days now. If the gap begins to decline due to rising five-year real yields, that would suggest investors expect faster rate increases from the Fed.
Yields have also been pushed higher by a series of technical factors including worries about constraints on bank balance sheets and the unwinding of leveraged bets linked to the relative yields of different Treasurys.
In the past week, there has also been a big pickup in outright bets by hedge funds that yields will keep rising and hefty sales of Treasurys by leveraged funds that trade based on market volatility, according to data from
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