By Saqib Iqbal Ahmed
NEW YORK (Reuters) – Relentless selling of U.S. government bonds has brought Treasury yields to their highest level in more than a decade and a half, causing disruption across multiple markets.
The yield on the benchmark 10-year Treasury – which moves inversely to prices – briefly reached 5% late Thursday, a level last observed in 2007. The surge is driven by expectations of the Federal Reserve maintaining elevated interest rates and mounting concerns over U.S. fiscal matters.
As the $25-trillion Treasury market is the foundation of the global financial system, the soaring yields on U.S. government bonds have far-reaching repercussions. The S&P 500 has dropped about 7% from its yearly highs as investors opt for the guaranteed yields of U.S. government debt over equities. Additionally, mortgage rates are currently at their highest in over 20 years, putting pressure on real estate prices.
“Investors need to carefully consider risky assets,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities in New York. “The longer we experience higher interest rates, the more likely something is to break.”
Fed Chairman Jerome Powell, on Thursday, expressed that the current monetary policy does not feel “too tight,” supporting the notion that interest rates are expected to remain high.
Powell also acknowledged the role of the “term premium” in driving yields. The term premium represents the additional compensation investors anticipate for holding longer-term debt and is measured using financial models. Recently, the rise in this premium was cited as a reason why the Fed may have less incentive to raise rates.
Let’s take a look at the various ways in which rising yields have impacted markets:
Higher Treasury yields can diminish investors’ interest in stocks and other high-risk assets by tightening financial conditions and increasing the cost of credit for individuals and companies.
Elon Musk cautioned that high interest rates could dampen demand for electric vehicles, leading to a decline in shares of the sector. Tesla’s shares closed the day down 9.3%, with analysts questioning the sustainability of the company’s exceptional growth compared to other automakers.
With investors gravitating towards Treasuries, where certain maturities currently offer yields above 5% for those holding the bonds until maturity, high-dividend paying stocks in utilities and real estate have been hit particularly hard.
The U.S. dollar has strengthened approximately 6.4% against peers in the G10 currencies since the rise in Treasury yields gained momentum in mid-July. The dollar index, which measures the strength of the dollar against six major currencies, is close to an 11-month high. A stronger dollar tightens financial conditions, potentially harming the balance sheets of U.S. exporters and multinational companies. Moreover, it complicates the efforts of other central banks to control inflation by weakening their own currencies. Traders have been closely monitoring the possibility of Japanese officials intervening to counter the sustained depreciation of the yen, which has weakened by 12.5% against the dollar this year.
“The correlation between the USD and rates has been notably positive and strong during the current policy tightening cycle,” mentioned BofA Global Research strategist Athanasios Vamvakidis in a note on Thursday.
The interest rate on the 30-year fixed-rate mortgage – the most popular home loan in the U.S. – has soared to its highest level since 2000, negatively impacting homebuilder confidence and mortgage applications. In an otherwise resilient economy with a robust job market and strong consumer spending, the housing market has been the most affected by the Fed’s aggressive measures to cool demand and control inflation.
U.S. existing home sales reached a 13-year low in September.
As Treasury yields surge, credit market spreads have widened, with investors demanding higher yields on riskier assets such as corporate bonds. Credit spreads widened after a banking crisis earlier this year but narrowed in the subsequent months.
The increase in yields has also elevated the ICE BofA High Yield Index to a four-month high, thereby raising funding costs for potential borrowers.
In recent weeks, there has been increased volatility in U.S. stocks and bonds as expectations regarding Fed policy have shifted. The anticipation of a surge in U.S. government deficit spending and debt issuance to cover those expenses has also unsettled investors.
The MOVE index, which measures expected volatility in U.S. Treasuries, is at its highest level in over four months. Equities have experienced increased volatility as well, with the Cboe Volatility Index reaching a five-month peak.
(This story has been refiled to add the dropped word ‘briefly’ in paragraph 2)
(Reporting by Saqib Iqbal Ahmed; Writing by Ira Iosebashvili; Editing by Stephen Coates)