Why is the 10-year Treasury yield plunging to its lowest since February? Public debt is Wall Street’s new meme asset, investor says

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The decline in US Treasury yields on Wednesday is proving to be a real headache for fixed income investors and the financial markets at large.

Earlier in the session, the 10-year Treasury note TMUBMUSD02Y,
0.224%
deepened its slide to the lowest level since February, hitting an intraday nadir Wednesday morning at 1.285%, according to FactSet data.

The decline in benchmark debt yields, used to price everything from mortgages to corporate debt, has baffled investors as it comes at a time when concerns about soaring inflation are high.

The constant rise in prices is bad for long-term debt because it can reduce the fixed value of the treasury. So instead of being bought, long-term bonds should be sold and yields should rise accordingly.

Most analysts had predicted 10-year Treasury yields to hit around 2% at this point in the recovery from the COVID-19 pandemic.

FactSet data


However, this did not happen, leading some on Wall Street to try to discern movements in Treasuries, including a flattening of the yield curve, or a difference between the yields of short-term notes and longer term bonds mean for the economic outlook.

Check: What to expect if the “full peak” has already happened and the markets are feeling the force of gravity again

The Pain Trade

Bets on higher yields have been a losing bet on Wall Street, and the unwinding of certain positions has contributed to some aspect of the long-term decline in yields.

Most traders are positioned for 10 year yields at or around 2% in the short term as this is a bet that makes sense given that some Federal Reserve policymakers have made plans to possibly reduce monthly buying. assets that include some $ 80 billion in treasury bills. .

Periodic increases in yields have forced a number of short Treasury bet unwinds, amplifying recent moves, analysts said.

“And right now with rates, pain trading is a continuous downward and flat movement,” wrote Greg Faranello, head of US rates at AmeriVet Securities, in a note Wednesday.

Weaker economy

The darkening outlook for a rapid economic recovery, evidenced by an uneven labor market rebound, may also contribute to the traditional purchase of safe-haven treasury securities.

American businesses are struggling to fill millions of available jobs. Although the United States created 850,000 new jobs in June, it would take more than a year at this rate to restore employment to pre-pandemic trends, a much slower rebound than economists expected there to be. a few months.

The number of available jobs on Wednesday set a record for three consecutive months, with May producing a record 9.21 million openings.

Certainly, many expect the job market to normalize as fiscal stimulus to help unemployed Americans kick in in the coming months, forcing a fuller return to work.

Mizuho economist Steven Ricchiuto, in a Wednesday research note, wrote that there are signs of layoffs and departures that imply this is only a temporary challenge for companies looking to fill jobs.

“Layoffs have fallen to a new all-time low, and the level of hiring and departures has declined and is now closer to their pre-pandemic levels,” the Mizuho economist wrote. He continued:

“This is somewhat worrying because it suggests that recent net payroll gains are not sustainable. Overall, these dynamics provide some support for the Fed hawks’ argument that the structural unemployment rate has increased. However, the policy changes that lead to these changes will largely be reversed over the next few months, so in our opinion, at a minimum, it is very premature to conclude that the labor market has structurally changed.

Treasure’s appetite

Demand for US government debt has been strong, especially as investments outside the US offer returns of 0% or less. German bond yield TMBMKDE-30Y,
0.185%
reached its lowest level since March. This appetite for European debt has spilled over into the United States, according to investors.

“The moves appeared to be more the result of the trading halt rather than something more fundamental,” Mizuho analysts wrote in a report. quoted by Reuters.

“There is still a lot of liquidity to implement, and the possibility of momentum funds closing short positions ahead… could keep short-term rates strong,” Mizuho said.

Delta, delta, delta

Concerns over the rapidly evolving delta variant of the coronavirus that results in COVID-19 have also been blamed for some purchases of Treasurys.

The delta variant is now the most dominant form of SARS-CoV-2 in the United States, according to new data Centers for Disease Control and Prevention. The more transmissible version of the coronavirus has raised concerns that it may no longer cause infections in the unvaccinated, and even the vaccinated may have less protection against the delta variant than other worrisome variants.

A shortage of supply

A lack of T-bill supply can also be a problem, which may seem odd, given the huge budget deficits the federal government has racked up in its efforts to cushion the economy against the COVID-inspired downgrade.

However, the General Treasury Account, or TGA, which the US government uses to manage most of its day-to-day operations and is managed by the New York Fed, is now being phased out after being put in place to help alleviate the crisis. economic. pandemic pain.

The reduction in the TGA has had the effect of reducing the supply of bonds, a key factor in recent movements in yields, argues John Luke Tyner, a bond analyst at Aptus Capital Advisors, which manages some $ 3 billion.

“We just had less emissions because the government can count on TGA to fund the spending,” Tyner said.

The Fed

The Federal Reserve statement and the press conference by Fed Chairman Powell after the crises of June 15 and 16 highlighted the odd place where fixed income investors find themselves. and mortgage-backed bonds, as well as the possible increase in key interest rates, which are in the range of 0% to 0.25%.

A Fed on a more hawkish basis, which suggests the institution will be more inclined to remove monetary accommodations as the economy recovers, should push yields higher.

Investors will be eager to glean clues about future policy from the June Fed meeting minutes when released on Wednesday afternoon.

2% or bust?

Despite the drop in yields, a number of analysts are still confident that the 10-year Treasury will hit 2% by the end of 2021, which would perhaps mark a dramatic surge in the last half of the year.

“We expect the 10-year US Treasury yield to end the year at 2.0%,” writes Lauren Goodwin, economist and portfolio strategist at New York Life Investments, in a recent research report.

She argues that the slow recovery in employment is temporary, while the increase in debt and other factors will not lead to a persistent change in inflation.

“My estimate of these structural factors suggests that the underlying inflation trend will only firm up modestly as the recovery continues … For now, any determination that they will be inflationary beyond the 2 -The next 3 years remains somewhat speculative, ”she wrote.

Tyner of Aptus Capital says that if the 10-year drops below 1.20% in its decline, then it could signal more structural problems in the economy, as assessed by fixed-income investors.



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