Monday’s sharp selloff in major U.S. stock indexes highlighted investors’ mounting concern that the biggest risk to markets right now is underwhelming growth, rather than the runaway price increases feared earlier in the year. At the same time, many investors think inflation readings may run hot for some period, then subside on their own or lead the Federal Reserve to raise interest rates and slow the recovery.
The yield on the benchmark 10-year U.S. Treasury note settled Tuesday at 1.208%, according to
up slightly from Monday but still down from 1.3% Friday and its 2021 high of 1.749% set in March.
Yields, which rise when bond prices fall, climbed sharply earlier in the year, lifted by bets that the U.S. economy would reach full employment with remarkable speed because of a vaccine-fueled recovery juiced by large-scale government spending.
Adding to the rise were signals from Fed officials that they would hold off raising interest rates until after inflation climbed above their 2% target for a sustained period. That bolstered investors’ confidence that the Fed would let the economy run hot, creating sustained inflation that the central bank could later control with well-timed rate increases.
A disappointing jobs report in May helped rattle that consensus. Though hiring has picked up in subsequent months, it has remained below the million-a-month pace that many had been anticipating. Meanwhile, the emergence of coronavirus variants has eroded optimism about the outlook for the entire global economy.
“The view that we expected to be having more fun at this point is relevant,” said
head of global G10 FX research and North America Macro Strategy at the Standard Chartered Bank branch in New York.
Earlier in the year, he said, investors were expecting outsize job gains and were pleased with the pace of coronavirus vaccinations. But by June, jobs numbers had disappointed and investors were “still seeing positive Covid-19 cases.”
The decline in yields has surprised many in part because it has come at the same time as data has pointed to a surge in inflation, reflected again earlier this month when the Labor Department said that the consumer-price index increased 5.4% in June from a year ago, the highest 12-month rate since August 2008.
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Often, faster inflation translates to higher short-term interest rates and higher bond yields. Many investors, though, have largely dismissed such gains, seeing them as exaggerated by comparisons to deeply depressed prices from last year and skewed by short-term supply disruptions related to the reopening of the economy.
If anything, inflation reports have helped pull longer-term yields lower by stirring fears that the central bank might raise interest rates too quickly and hurt the economy. Some analysts have also expressed concern that the sharp increase in consumer prices could slow growth by dragging on household spending.
Gauges of longer-term inflation expectations have actually declined in recent months. The 10-year break-even inflation rate, showing investors bets on average annual inflation over the next decade, was 2.24% Monday, down from 2.54% in May, according to Federal Reserve data. Break-even rates are based on the extra yield investors demand to hold nominal Treasurys over inflation-protected bonds.
One factor behind falling yields is the view that inflation in its present form is a “tax on consumption…not evidence of a healthy, overheating economy,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.
As yields have fallen in recent months, many investors have also argued that the decline was caused more by idiosyncratic factors, such as demand from pensions and foreign central banks, than any fundamental reassessment of the economic outlook.
Buttressing that view: Investors have continued to buy riskier assets, powering stock indexes to records and driving corporate bond yields to new lows. Beneath the surface, though, some analysts noted signs of concern even in the stock market, as investors increasingly favored large-cap tech stocks over those more sensitive to the economy.
One possible consequence of the bond rally is that lower Treasury yields, all else being equal, can help lift stock prices by lowering borrowing costs for businesses and pushing investors to buy riskier assets in search of better returns. Many investors also use the 10-year U.S. Treasury yield as a discount rate in formulas to value stocks, with a lower yield making the future profits of companies worth more in today’s terms.
Many, however, continue to believe that yields will eventually regain ground, arguing that the bond rally has overshot economic fundamentals.
John Sheehan, a fixed income portfolio manager at Osterweis Capital Management, said funds he manages are still positioned so that a move higher in yields wouldn’t hurt them as much as benchmark indexes.
“Even if inflation moderates back from 5-odd percent to 3-odd percent, we don’t think that’s consistent with a 1.18% 10-year note,” he said.
Write to Sam Goldfarb at email@example.com
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