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Yields on long-term US government debt were close to hitting their highest level since 2007 on Thursday as investors increased bets that the Federal Reserve would successfully deliver a soft landing — avoiding a recession, while keeping a lid on inflation with higher rates.
The sell-off in bonds — yields rise as prices fall — was mirrored in European markets, where UK 10-year gilt yields hit their highest since 2008 and Germany’s equivalent hit levels not seen since 2011.
Central banks on both sides of the Atlantic have maintained a hawkish stance even as inflation pressures have eased, leaving investors worried that the Fed and others are unlikely to let rates fall any time soon.
On Wednesday, minutes from the Fed’s last meeting showed members of the open market committee saw “significant upside risks to inflation, which could require further tightening of monetary policy”.
Dillon Lancaster, portfolio manager at TwentyFour Asset Management, said investors were still debating how central banks would react if they could pull off a “soft landing” where economic activity slows only gradually.
“The question we’ve been asking is if you get to a situation where inflation is under control and unemployment stays at very low levels — what do the central banks do?” said Lancaster. “Do they keep rates higher for longer and do yields at the long end have to drift a bit higher?”
Yields on benchmark 10-year Treasuries reached 4.318 per cent, up 0.06 per cent on the day and just shy of last October’s 4.3354 per cent intraday peak. However, measured on a daily basis — using a single reference price as many fund managers do — they reached 4.2939 per cent, their highest since November 2007.
Yields on 10-year UK gilts were 0.08 percentage points higher at 4.73 per cent while German Bunds offered 2.7 per cent, up 0.05 percentage points.
Rising yields weighed on stocks, with the tech-heavy Nasdaq Composite off 0.4 per cent in late-morning trade while the S&P 500 gave up opening gains to trade down 0.1 per cent.
“It doesn’t matter whether you think the Fed will or will not carry through with the lean in the Fed minutes,” said Stephen Innes, managing partner at SPI Asset Management. “The fact is that 10-year yields are soaring, and in the modern-day playbook for stock market operators, that is bad news on multiple levels.”
A string of economic data in recent months has indicated that the US economy has remained robust even as the Fed has taken interest rates to a 22-year high.
Adding to the list, the Philadelphia Fed Manufacturing index jumped to 12 in August, from minus 13.5, and well above the minus 10 consensus, marking its first positive reading in a year. Readings above zero mean the majority of survey respondents reported an overall expansion in manufacturing activity.
Shares of Walmart jumped 0.7 per cent after the retail giant beat Wall Street estimates on quarterly sales and profits and raised its full-year outlook, suggesting that US consumer spending has so far held up despite sharp rise in borrowing costs since the Fed began raising rates in March last year. Home Depot and Target reported strong earnings earlier in the week.
Investors warn that US yields could push higher still, as the US economy remains strong with very low levels of unemployment.
Until this month, however, yields on 10-year notes had struggled to stay above 4 per cent — a level common before the 2008 financial crisis, but not since.
“It’s surprising that 10-year US yields have spent so much time below 4 per cent recently,” said Robert Tipp, head of global bonds for PGIM Fixed Income.
“Investors are convinced that we are going to go back to a sub 4 per cent environment very soon and I think that expectation is likely to prove unfounded in the years ahead.”
Europe’s region-wide Stoxx Europe 600 closed down for a third consecutive day, off 0.9 per cent, while France’s CAC 40 fell 0.9 per cent and Germany’s Dax gave up 0.7 per cent.
The dollar followed yields higher and pushed the yen back to ¥145.76, its weakest level since November, as the gap between returns on US and Japanese government debt increased.
That pushed the yen below the level where the Japanese finance ministry stepped in to support the currency last year, and heightened speculation that it could intervene again. On Tuesday, finance minister Shunichi Suzuki said he was watching the market moves “with a sense of urgency”.
Equities in China steadied from a sharp sell-off earlier in the week, with the benchmark CSI 300 up 0.3 per cent, while Hong Kong’s Hang Seng was flat.
