U.S. Government Debt Selloff Continues, With 10-Year Yield at 16-Month High

Higher oil prices adding to expectations of higher inflation, driving investors to switch into TIPS


Updated Dec. 1, 2016 10:46 a.m. ET

The bond market rout is deepening.

The yield on the U.S. benchmark 10-year Treasury note rose to a 16-month high Thursday, following the biggest monthly increase in November since 2009. The yield touched 2.464% and recently was 2.448%, according to Tradeweb, compared with 2.365% Wednesday. Yields rise as bond prices fall.

Selling Thursday was driven by higher oil prices, which have extended Wednesday’s rally after the Organization of the Petroleum Exporting Countries reached a deal to curb the ongoing oil supply glut. Higher oil prices tend to boost inflation expectations, which chip away at bonds’ fixed returns over time and is a big threat to long-term government bonds.

The oil move drove investors to sell Treasury debt and buy Treasury inflation-protected securities on Thursday. The allocation sent the 10-year Treasury note’s yield premium over the 10-year TIPS to 1.98 percentage points, the highest since Oct 2014.

That level suggests that investors expect U.S. inflation to run at an annual rate of 1.98% on average over the next 10 years. Known as the 10-year break-even rate, it had soared by 1.36 percentage points shortly after the Brexit vote. The break-even rate last traded at 2%—the Fed’s inflation target—in September 2014, a level some analysts say is likely to break soon if the inflation bets gain more traction.

A solid U.S. manufacturing release Thursday boosted optimism toward the U.S. growth outlook, driving more investors to sell Treasury debt, which is typically a haven when the economy falters. The nonfarm U.S. jobs report is due Friday, and is one of the most important monthly economic statistics. Traders say an upbeat report could fuel more selling in bonds.

The 10-year Treasury yield has by soared more than 1 percentage point from its record low set in July. The selloff has been intensifying after the U.S. election in early November. Investors had bet that the prospect of expansive fiscal and economic policy under the new U.S. administration would lead to stronger growth, higher inflation and potentially a faster pace of interest-rate increases by the Federal Reserve.

This represents a big shift away from the notion of soft growth and low inflation that had been a main driver sending investors piling into Treasury debt and sovereign bonds in other developed countries, driving bond yields to historic lows this summer.

Higher Treasury bond yields have rippled globally as the selloff wiped out more than $1 trillion from the global government bond universe based on the changes of market value from Bloomberg Barclays indexes data.

Some of the world’s large money managers have changed their view that yields would stay lower for longer.

”We are moving to a new regime in the bond market,’’ said Nick Gartside, international chief investment officer of global fixed income at J.P. Morgan Asset Management, which had $1.8 trillion assets under management as of September 30.

Mr. Gartside said he believes that Treasury bond yields had hit rock bottom in July following a 35-year span of lower yields. He said the 10-year yield would rise to 3% during 2017—a level where it had last traded in early 2014. Reflecting his yield expectation, he has cut his Treasury bondholdings recently and preferred corporate bonds. He said bonds sold by lower-rated corporate-debt issuers are attractive amid a brighter growth outlook.

The sharp rise in yields reminds investors of the taper tantrum episode in 2013 when worries over a cut in the Fed’s bond-buying program rattled the bond market. Now some investors are concerned that the bond rout may again spook investors and cause heavy outflows from bond funds. Analysts warn that this would generate further selling pressure in the bond market and lead to much higher yields from here.

”It is absolutely a risk,’’ said Erik Schiller, senior portfolio manager for global government bonds at Prudential Financial Inc.’s fixed-income unit.

Some investors believe bond yields have room to rise. They argue that higher Treasury yields are a healthy sign as it reflects a brighter assessment of the economy.

Traders say a solid nonfarm U.S. jobs report due Friday could add more selling pressure in the bond market. Some expect the 10-year yield to break 2.5% if the selling intensifies.

Bond yields remain low from a historical standpoint. The 10-year yield traded at 3% in early 2014. Even with the rise this month, it is less than half of the level where it had traded in 2007.

Some large money managers say higher yields are a boon for long-term investors.

While higher yields shrink the value of outstanding bonds, they allow investors to invest new cash at more attractive yields. That is a boon for people near retirement or who have already retired as they have been struggling to generate income in a low-yield world.

Higher yields are a boon to pension funds and insurance firms too. These institutional investors need high-grade long-maturity debt to match their long-term obligations. Traders say some have been buying long-term Treasury debt over the past week.

”Over the long haul, reinvesting at higher rates will boost your overall returns,’’ said Gemma Wright-Casparius, senior portfolio manager of the fixed-income group at the Vanguard Group.

Write to Min Zeng at min.zeng@wsj.com




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One Response to “U.S. Government Debt Selloff Continues, With 10-Year Yield at 16-Month High”

  1. daveyone1 Says:

    Reblogged this on World Peace Forum.

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