Thursday, February 3, 2022
With the recent hawkish pivot by the Federal Reserve (Fed) indicating a now quicker removal of monetary accommodation, U.S. Treasury yields have moved higher to start the year. Over the past few months, the Fed has indicated it will end its bond buying program in March, start its interest rate hiking campaign (likely starting in March with five hikes expected currently), and potentially reduce its nearly $9 trillion balance sheet (likely starting in July). The sudden shift in expectations has caused the 10-year Treasury yield to increase by nearly 30 basis points (0.30%) so far this year. However, the sharp rise in interest rates is not unique to the U.S.
“The hawks are winning the inflation debate right now and markets have quickly repriced interest rate hike expectations globally,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “And while the rise in interest rates has been sudden, those investors that need additional income likely welcome the additional yield”.
Also dealing with stubbornly high consumer price pressures, interest rate hike expectations for the European Central Bank (ECB) and Bank of England, to name a few, have also increased. Currently, markets are expecting the BOE to hike nearly five times this year (including today) and markets expect the ECB to hike rates twice this year. As such, and as seen in the LPL Chart of the Day, interest rates have moved higher globally. We’ll see if the ECB and/or the BOE push back on these market expectations during their respective meetings today.
Also of note, yields on 10-year German, Japanese, and Greek government bond yields have moved higher this year and, in the case of German Bunds, have turned positive for the first time since 2019 (0.036% as of 2/02/22). Japan’s 10-year government bond yield, after hovering around zero for years, has jumped to 0.17%, the highest since 2016. Finally, one of the largest increases in interest rates this year has been the 60 basis point increase in 10-year Greek debt. Greek debt has been benefitting from the ECB’s emergency asset purchase program since the COVID-19 pandemic began, but the ECB plans to wind down the program this year and Greek government bonds may not be eligible for new central bank asset purchases. As such, we’ve seen a big sell-off in Greek debt.
So what does this mean for U.S. fixed income markets? Foreign investors in U.S. Treasury markets are an important reason we haven’t seen U.S. 10-year yields move even higher. As international interest rates move higher though, it becomes less likely that we’ll see the amount of crossover foreign investors needed to help keep our Treasury yields from climbing higher. Moreover, as the Fed starts to reduce its balance sheet, demand for U.S. Treasury securities will need to increase to offset the Fed’s reduced footprint. If investors outside the U.S. are no longer as interested in our markets (because their home rates are higher) we may need to see higher yields here to induce additional demand.
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