Bond Selloff Rattles Markets

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A fall in bond prices has pushed the 10-year Treasury yield to 1.769%, the highest since the start of 2020

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The worst week for 10-year notes since 2019 wasn’t a disaster for stocks — the S&P fell 1.9% — and it didn’t come as a complete surprise. Investors widely expected yields to rise this year as the Federal Reserve began raising short-term interest rates. Stock indexes have generally performed well in years when the central bank was in the early stages of monetary policy tightening, and many analysts expect a repeat this year, thanks to continued growth in corporate earnings.

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Nevertheless, the bounce in returns happened faster than most anticipated and gave rise to significant volatility. The Nasdaq Composite plunged 4.5% in its worst week in more than 10 months, as rising yields hit stocks of technology companies and other businesses, which have gained much of their value from hopes of further gains in the future. We do. Salesforce.com dropped 10% for the week. The ARK Innovation ETF declined 11%.

Rising interest rates can hurt stocks in a number of ways, from increasing corporate borrowing costs to providing investors with an alternative means of earning good returns. The effect on so-called growth stocks is larger because investors tend to underestimate uncertain future profits when they can get more guaranteed income from Treasuries. Higher yields also drive up borrowing costs for consumers, with the average 30-year mortgage rate hitting a nearly two-year high last week at 3.22%.

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Increasing yields isn’t all bad news. On short-term bonds, they reflect expectations of a Fed rate hike. But on longer-term bonds, they indicate confidence that a rise in those rates will not lead to a recession. Shares of businesses in financially sensitive sectors such as banking, industry and energy generally rose last week, with the S&P 500 financial sector rising 5.4% on its best five-day start in a year since 2010.

Last summer, when the delta version caused a spike in Covid-19 cases, investors piled on bonds and technology stocks at the expense of some cyclical stocks. Now, during another Covid-19 wave driven by the more contagious but seemingly less severe Omicron version, investors are doing the opposite, a sign they think “the economy is still very strong when we count on cases.” growth,” said Michael Aron, chief investment strategist at State Street Global Advisors.

Still, last week served as a clear reminder that momentum can change rapidly even in a stable Treasury market, denying investors a gradual climb that many say is more easily coped with by other assets. Will be done. Traders said Monday’s selling especially stemmed from no fundamental catalyst. Rather, investors such as hedge funds that slowed trading in late 2021 began betting on higher interest rates again.

The next day, the sale was fueled by a report in the Wall Street Journal detailing how Fed officials were starting to think about reducing the size of the Fed’s $8.76 trillion portfolio of Treasury and mortgage securities. Were — probably not long after the Fed stopped adding to that portfolio around the end of March.

Minutes of the Fed’s December meeting, released on Wednesday, further raised expectations that the central bank could start raising interest rates at its March meeting – earlier than many investors had previously anticipated.

Selling continued on Friday after data was released showing employers added fewer jobs than expected in December, with investors seizing the drop in the unemployment rate and growth in workers’ incomes as evidence of a very tight labor market. .

Investors and analysts point to one simple reason why yields could climb this year: Despite the recent sell-off, bond yields still reflect investor expectations that the Fed will not raise rates as much as central bank officials have predicted. indicated that they think it is likely.

Interest rate derivatives suggested Friday that investors expect short-term rates to reach around 1.7% in four years and then hang around that level for the rest of the next decade. In contrast, most Fed officials indicated in their last meeting that they expect rates to average 2.5% over the long term. This estimate does not account for the possibility that the central bank may raise rates above that so-called neutral level to slow the economy and curb inflation.

Still, many investors remain skeptical that the Fed will be able to raise rates to 2.5%. Some point to past economic expansion, when the central bank raised rates so high that only to retreat sharply when growth began to falter and stocks fell sharply. Many investors also think that last year’s inflation growth will subside substantially this year without the help of the Fed.

Zhiwei Ren, fixed-income portfolio manager at Penn Mutual Asset Management, said his team is positioned to increase yields across nearly all Treasury maturities this year. Still, yields on long-term Treasuries will continue to climb only if Fed officials carefully choose the middle ground, with investors confident that short-term rates will rise but still optimistic about the economy, he said.

“If you want rates to go higher,” he said, “you want the Fed to be the right amount of hawkish.”

Write to Sam Goldfarb at [email protected]

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