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Signs of continued U.S. labor market strength plus persistent inflation out of Europe were all it took this week for bond investors to push yields up toward new milestones as interest-rate expectations continued to be readjusted.
The 10-year Treasury yield
TMUBMUSD10Y,
finished Thursday’s U.S. session above 4% for the first time since November and ended below that mark on Friday.
BMO Capital Markets strategists Ian Lyngen and Ben Jeffery said the benchmark rate is near the top of what they see as a 100-125 basis point trading range centered around 3.5%, meaning the rate could go as high as 4.5% or 4.75% at some point if bond-selling momentum continues.
For now, Lyngen and Jeffery are putting the 10-year yield’s 4.241%-4.335% intraday peaks reached late last year back on the map.
Source: Tullett Prebon, data as of Thursday.
March marks the first anniversary of the first Federal Reserve interest rate hike of the current tightening cycle, and the outlook for inflation across developed markets has only gotten murkier since.
U.S. data on Friday, produced by the Institute for Supply Management, showed business conditions at service-style companies, such as hotels and hospitals, holding steady at a robust level in February. That came a day after weekly U.S. initial jobless claims came in below 200,000 for the seventh week in a row for the end of February, a sign of continued labor-market strength. Meanwhile, inflation hasn’t fallen as much as expected in either the U.S. or the eurozone, with the latter recording an annual CPI inflation rate of 8.5% for last month.
Together, that’s added up to 4%-plus yields across much of the Treasury market, though the 10- and 30-year rates BX:TMUBMUSD30Y pulled away from that level on Friday.
As with almost everything in financial markets, bond trading is a two-way street. Yields tend to back up each time inflation fears prompt investors to sell off bonds. Those rates then start to ease down again as a fresh pool of investors, attracted by higher yields, jump back in to buy fixed income at more appealing returns than they might get elsewhere, such as in stocks.
The latter scenario is what unfolded on Friday, as buying demand re-emerged and pushed the 10-year yield down to 3.962%.
“We don’t believe the 10-year can stay over 4% for a long period of time without affecting the economy, and we expect to see an increase in unemployment as we move through the year,” said Rhys Williams, chief strategist at Spouting Rock Asset Management, which oversees $2.3 billion in assets from Bryn Mawr, Pa.
“We wouldn’t get too negative on stocks and bonds, because we think both stocks and bonds will rally hard at the first sign that PCE inflation is slowing and unemployment is increasing, and we think that is likely in the next three months,” Williams said.
The 10-year yield’s 3.962% finish in Friday’s New York trading session is down from 4.072% on Thursday. Thursday was the first time that the rate had ended above 4% since Nov. 9, 2022. Prior to last October to November, the yield hasn’t consistently traded above 4% since 2007-2008.
Fed policy makers have delivered 450 basis points worth of tightening in the past year, taking their benchmark rate target to 4.5% and 4.75% from almost zero. On Friday, fed funds futures traders slightly boosted their expectations for a quarter-of-a- percentage-point rate hike on March 22 and largely kept intact their views on a 5.5%-plus interest rate by September.
Remarks by Atlanta Fed President Raphael Bostic took the edge off some of the market’s moves this week. Bostic said the central bank could be in a position to pause rate hikes this summer, which helped send U.S. stocks
DJIA,
COMP,
to a solidly higher finish on Thursday and Friday.
Over the last month, “inflation expectations have spiked back and 2yr and 5yr U.S. breakevens are now at 7-month and 4-month highs, respectively,” said Deutsche Bank’s Jim Reid, in a note. “To be frank, the inflation call is now tougher than it was in 2020-2022,” describing it as a “sticky and messy outlook.”
“Further ahead, structural forces are becoming inflationary, including those relating to deglobalisation and demographics,” Reid wrote. “But in the near term, inflation will likely be sticky until the monetary overhang has been eradicated and the U.S. recession we expect hits later this year. After that, we could fall sharply given current monetary trends and the lag of policy, before the structural forces re-emerge again in the next cycle.”
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