The financial Twittersphere’s latest member couldn’t help but crow over the Treasury market’s recent setback. “Where are all the investors who turned bullish at 2.17 per cent, talking about a 1.5 per cent target?!?!”, DoubleLine Capital’s Jeffrey Gundlach tweeted on Wednesday, referring to the 10-year Treasury yield.
This is tilting at windmills. Few investors have ever predicted that the benchmark Treasury yield will fall that low. But the bond fund manager’s Treasury calls have been pretty accurate, and he was right to highlight a steady, silent but notable sell-off in US government debt in recent weeks.
After touching a five-month low of 2.17 per cent in mid-April, the yield on the 10-year Treasury has jumped to 2.4 per cent, driven by expectations that growth will rebound from the first-quarter disappointment and that the Federal Reserve will lift interest rates again in June. The odds on that are now as high as 88 per cent, according to the CME’s FedWatch tool. In other words, the rate increase is already in the mail as far as markets are concerned.
Treasuries found some support on Thursday, but the Fed could spring a surprise that would quicken the sell-off. Despite two rate increases over the past half-year, “financial conditions” — a measure of the net economic impact of factors such as currency movements, bond yields, volatility, money flows and the stock market — have continued to slacken. That will spur the central bank to act more aggressively, Jan Hatzius at Goldman Sachs predicts.
That would unsettle investors who remain sceptical even of the Fed’s existing plans to lift its interest rate corridor twice more this year. Fed funds futures imply only a 46 per cent chance of the central bank doing so in 2017, and only a 16 per cent possibility of the Fed accelerating its pace. So Friday’s inflation and retail data could exacerbate pressures on Treasuries.
Still, the longer-term gravitational forces pinning down bond yields remain in place. So the safest bet is for the Treasury yield curve is to flatten, as long-maturity bond yields stay subdued even as the Fed lifts short-term interest rates. The difference between two and 10-year US government debt yields currently stands at 105 basis points. It will probably be in double digits again soon.
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