By Min Zeng
After a brief respite, renewed selling pressure Friday sent the yield on the benchmark 10-year Treasury note to an 11-month high, setting the yield up for the biggest two-week increase in 15 years.
The latest leg added to the bond market rout that kicked into high gear after the U.S. presidential election earlier this month. The prospect of large deficit spending, lower taxes and lighter banking regulation advocated by President- elect Donald Trump has been the central narrative feeding a scramble to cut bondholdings.
Money managers are concerned that this policy outlook will lead to stronger U.S. economic growth, higher inflation and tighter monetary policy. This is causing investors to reassess the bond market outlook, with debate growing over whether this marks a shift away from the long cycle of low yields in place since 1981.
Analysts caution that it is premature to draw a conclusion. Bond bears have signaled false alarms from higher yields in the past. Still, for investors and traders who subscribe to the view that bond yields are normalizing from rock bottom levels, they are selling long-term Treasury debt to hedge against the risk of further increases in yields.
"We are entering into a new phase in the bond market," said David Coard, head of fixed-income trading at Williams Capital Group. "As a bond investor you need to get defensive because yields are likely to rise more from here. That means more pain for bondholders."
Mr. Coard is advising clients to cut holdings of long-term Treasury debt.
The yield on the 10-year Treasury note touched 2.351% earlier Friday. It was recently at 2.324%, according to Tradeweb, up from 2.278% Thursday.Yields rise as bond prices fall.
The selloff has wiped out the yield's big decline earlier this year, a development that few investors had seen coming.
Investors had enjoyed decent returns from the bond market as yields sank to record low levels in early July following the U.K.'s referendum to leave the European Union.
While yields remain very low from a historical standpoint, the sharp rise is inflicting pain on investors, especially those buying bonds at record low levels.
The Treasury bond market has posted a negative 2.32% return--including bond price gains and interest payments--this month through Thursday, according to data from Bloomberg Barclays U.S. Treasury index. It is on pace to be the biggest monthly negative return since December 2009. For the year, the index still logged a 1.5% return, but a further selloff in the bond market could wipe out the positive return.
Investors pulled a net $43.2 millionout of U.S. mutual bond funds targeting the Treasury bond market for the week ended Wednesday, according to fund tracker Lipper. That was the biggest weekly outflow since a net redemption of $49.9 million in March 2015.
Analysts say the reason why bond yields have jumped so much is that before the election data had pointed to an improvement in global manufacturing and an uptick in inflation pressures. This week's solid retail sales, housing starts and labor market releases in the U.S. bolstered optimism over the resilience of the U.S. economy.
Some expect the 10-year yield could rise to 3% in 2017, a level last traded in early 2014.
Not everyone is subscribing to the view that the cycle of low yields is over.
Larry Milstein, managing director of government and agency trading at R.W. Pressprich & Co., said the 10-year yield around 2.3% "seem to attract dip buyers," reflecting a view that the sharp rise in bond yields sincethe election may be overdone.
Many investors have been shedding bondholdings and piling into stocks as they believe that large fiscal spending, lower taxes and lighter banking regulations advocated by Mr. Trump will lead to stronger economic growth, higher inflation and a faster pace of interest rate increases by the Federal Reserve. These elements tend to shrink the value of outstanding bonds. Inflation, in particular, is a big threat to long-term government bonds.
Investors and analysts warn that bond yields still have further room to rise in the months ahead, leaving bondholders vulnerable.
The bond market rout is raising debate whether it marks the start of a reversal from a prolonged cycle of low yields since 1981. After closing at a record low of 1.366% in early July, the 10-year yield has been soaring. Some traders and analysts say the summer low may have marked the rock-bottom level for the yield.
The key rationale, they argue, is that the bond market is on the cusp of a regime shift. For years, low growth, low inflation and ultraloose monetary stimulus have been the key factors driving investors to buy government bonds, sending yields sinking.
Now the narrative is starting to shift the other way, which is higher growth, higher inflation and less accommodative monetary policy support.
Some investors point to the uncertainty regarding Mr. Trump's policy. They question how big the fiscal stimulus will be and how much of a boost it could give to the broader economy. In addition, they are concerned about Mr. Trump's trade protectionism stance which may hurt the U.S. growth outlook.
Analysts reckon the dark side of a sharp rise in yields if they pick up more traction from here. Treasury bond yields are benchmarks to set long-term borrowing costs for consumers and businesses. U.S. mortgage rates have been rising on the back of higher Treasury yields.
Higher Treasury yields also raise the borrowing costs for foreign governments and firms raising capital in U.S. markets. Furthermore, higher U.S. bond yields are boosting the appeal of the U.S. dollar, generating risk of capital flight out of developing countries and threatening to cause chaotic declines in emerging-market bonds and currencies.
Write to Min Zeng at email@example.com
(END) Dow Jones Newswires
November 18, 2016 13:45 ET (18:45 GMT)
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