Investors got a reading on Monday morning that they hadn’t seen since June: the 10-year Treasury yield briefly back up above 1.5%.
The move upward in the yield, which began last week and as of early afternoon on Monday is now hovering around 1.48%, comes at a time when the Federal Reserve is signaling it may start tapering its asset purchases soon, while central banks globally turned a touch more hawkish in recent weeks. Treasury yields move opposite to prices.
According to Lawrence Gillum, fixed income strategist for LPL Financial, the main reason for the trek upward in yields? Central banks and the expectation of “stickier” inflation.
“Last week was a big week for central banks,” Gillum told Fortune. “The tone with a lot of these central banks has become slightly more hawkish—you know, we’re hearing a lot more central banks talk about maybe inflation is going to be a bit higher than they thought originally and maybe a bit longer than they thought originally.”
The yield reaction was more “prevalent” last Thursday, he noted, when yields spiked higher amid the Bank of England raising their inflation forecast one day after the Fed upped theirs (the Fed is expecting inflation to top 4% in 2021, while it may eye hiking rates in 2022). Meanwhile the European Central Bank has also recently signaled higher inflation expectations, while other countries like Norway are even starting to hike interest rates.
“I think it’s just a combination of … the bond market repricing the amount of inflation over the next year or two, and then maybe just the central banks becoming a touch less supportive over the coming year or two as well,” Gillum said.
Others like Kathy Jones, chief fixed income strategist at Charles Schwab, agreed that bond investors are repricing inflation expectations, but she suggested the main factors contributing to the recent rise in yields is “the mid-cycle slowdown is increasingly looking like it’s behind us; economic growth is continuing to be pretty firm, [and] we’re seeing inflation pressure from both the supply side and demand side,” she told Fortune. “Mainly we just have good economic data that justifies yields moving up,” suggests Jones. (She expects yields moving forward in the 1.65% to 1.75% range, depending on jobs data.)
Monday morning’s durable goods orders and core capital goods report showed strong growth from the prior month. Oil prices, meanwhile, are also on the rise. The latest inflation print via the consumer price index showed a slower pace of inflation in August than previous months, but prices are rising.
“A lot of these recent economic data releases talk about just continued increasing prices and … the input prices are increasing,” while workers are “still in demand and still hard to find,” LPL’s Gillum notes. “All these things put continued pressure on inflation and consumer good prices, so that story hasn’t changed.”
Also looming on the horizon in the near term is a debate about the debt ceiling, as the U.S. is set to default on its debt if action isn’t taken by Congress. But Schwab’s Jones doesn’t “think investors are really worried about it or pricing it in,” she said. “Not to say that it isn’t a risk, but … I don’t know a lot of investors who are willing to risk putting on a position in anticipation of some sort of debt ceiling crisis when it never actually happens.”
And although Wall Street has been a bit more concerned about slowing economic growth of late, with some firms estimating lower GDP, those like Lindsey Bell, chief investment strategist at Ally Invest, suggest “Fed Chair Jay Powell confirmed the economy has almost hit its ‘substantial further progress’ threshold, even though COVID has caused a deceleration in economic momentum. To us, that sounds like the Fed thinks the slowdown is temporary and could resolve itself as this COVID spike cools down,” she wrote in a Monday report.
The main thing bond investors are going to be watching, suggest Gillum and Jones: the labor market, and what it means for the economic picture and the Fed’s tapering timeline.
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