Cloudy economic outlook causes chaos in safe haven bonds
Wild swings in the bond market have rattled investors as they try to decipher the US Federal Reserve’s next move amid a soaring supply of Treasuries, the prospect of a wider conflict in the Israel-Hamas war, and a robust economy that could face further tightening.
The yield on the benchmark 10-year US Treasury note briefly breached the 5 per cent level again on Monday, to the highest in 16 years, before tumbling to 4.84 per cent. It has jumped 160 basis points since May.
The yield on the two-year Treasury note stood at 5.07 per cent, taking the gap between two-year and 10-year bonds to minus 22 basis points. A yield inversion in that part of the curve – when short-term borrowing rates exceed long-term ones – is a reliable indicator of a looming recession.
Bonds, regarded as a safe haven in times of economic uncertainty, have been on a tear since May amid a sharp increase in bond supply to fund a widening US fiscal deficit and expectations the Fed will keep interest rates high for longer.
Returns at the long end of the curve rose after Fed chairman Jerome Powell said last week that the robustness of the US economy and a strong labour market could warrant tighter financial conditions.
The 10-year Treasury yield, a benchmark for borrowing costs around the world, shot higher on expectations of stronger-than-expected US growth following a string of positive economic data releases.
On Thursday, the US will release September quarter gross domestic product growth which is tipped to expand 4.3 per cent at the annualised rate, from 2.1 per cent in the second quarter.
Nikko Asset Management argues that markets are playing catch up, having previously wrongly predicted future rate cuts and an economic recession.
“It is clear now that the market didn’t get that call right,” James Alexander, joint head of global multi asset at Nikko Asset Management Australia, said. Late last year, US 10-year yields went below the Fed funds rate at a time when the Fed still had 150 basis points of rate rises to deliver.
“It seemed like markets got really confident that the Federal Reserve was almost done. And as it turned out, they weren’t.”
Some of the market’s most prominent bond bears, billionaire hedge fund investor Bill Ackman and Bill Gross, the co-founder of Pimco, agree that the historic rout in US Treasuries has gone too far and abandoned negative bets against the bond market.
Australian bond yields have also had a wild ride. The 10-year rate climbed as far as 4.74 per cent on Monday, a level last seen in 2011, before easing to 4.69 per cent. It has jumped 144 basis points since May.
The pullback in US Treasuries weighed on the US dollar which, in turn, lifted the Australian currency to US63.60¢. The local dollar has shaved off nearly 7 per cent against the greenback this year, largely on interest rate differentials between the US and Australia.
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