Evening Brief – 08.18.23
Bond Blues
Movements across the global government bond markets have been shockingly volatile this week. The US 10-year yield traded as high as 4.32% on Thursday, its highest level in 15 months; a close above here would be the highest close since 2008.
On a three-year basis this week’s moves have been the largest since the 1980s.
The US 30-year yield shot up to 4.42%, slightly exceeding last year’s high, and the highest intraday level since 2011; it was below 4% just three weeks ago. The UK 10-year yield jumped to a 15-year high, while the German 10-year yield reached its highest level in 12 years.
The yield on a Bloomberg index for total returns on global sovereign debt rose to 3.3% Wednesday, the highest since August 2008, making the asset class the worst performer across Bloomberg’s major debt indexes.
The bond market’s woes were exacerbated by an unexpectedly weak 20-year bond sale in Japan, reflecting growing speculation that the Bank of Japan’s Yield Curve Control (YCC) will be eased – again.
It’s also a significant warning for global government debt at a time when yields are rising sharply. Soaring Japanese government bond yields would put further upward pressure on the rest of the world’s debt yields.
Meanwhile, the FOMC, in its July 25-26 minutes, continued to voice concerns about inflationary pressures and that additional tightening would be needed. While many investors had believed the central bank was done raising interest rates, that’s no longer a sure bet. As a result, it’s adding to the volatility in the global bond markets.
China also continued to weigh on market sentiment. According to Bloomberg, the outlook from property agents and private data providers suggests the slump in the real estate market may be worse than official reports show.
The data show existing home prices falling at least 15% in prime neighborhoods of major metropolitan areas like Shanghai and Shenzhen. China also aggressively boosted efforts to curtail losses in the yuan on Thursday by offering the most forceful guidance since October through its daily reference rate.
There will be more demand for duration when it is evident that the Fed is getting closer to easing. But we aren’t there yet. Moreover, the combination of fiscal instability, as warned by the ratings agencies, a slowdown in Treasury purchases from China and a looser bond policy in Japan will keep global government bonds under pressure.
A 4.25% 10-year yield makes some sense, however. Assuming a 2.50% inflation rate and a 2% real yield, it’s only high if you’re under the impression that yields will return to the era of 2% or 3% yields when the Federal Reserve was flooding the system with stimulus through its quantitative easing program. But we are well beyond that environment now.