Why Treasuries have been clobbered lately

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The renewed surge in US government bond yields despite falling inflation and signs that the Federal Reserve really is finally going to stop hiking rates seems to have mystified some people.

The 10-year Treasury yield has climbed by about half a percentage point over the past month to 4.32 per cent at pixel time. Here’s JPMorgan’s rates team on the myriad drivers that people have pinpointed in recent days:

There is no shortage of theoretical drivers of the recent move given the perfect storm of events over recent weeks — upward revisions to growth forecasts, as economic resilience in the face of tighter monetary policy has driven expectations of higher neutral policy rates (r*); Fitch’s downgrade of the US sovereign rating the same week that Treasury announced plans for increasing longer-duration debt issuance, in the wake of a BoJ YCC tweak that drove BoJ yields higher, and a Fed that signaled QT could extend well beyond the timing of the first rate cut.

However, of all these, JPMorgan’s analysts Phoebe White, Liam Wash and Holly Cunningham reckon that the surprisingly resilient economic backdrop — and the implications for inflationary pressures — is the biggest factor.

In a “postmortem” of the Treasury sell-off published late on Friday, they pointed out that the 10-year Treasury yield was previously trading about 20 basis points below where you’d expect based simply on the strength of the economy and the inflation outlook.

Further upward revisions to economic growth and inflation forecasts since then add another 20 bps to what they think the “fair value” of 10-year USTs are — about 4.20 per cent.

With the 10-year note is trading at 4.32 per cent, so this would explain most of the move if obviously not all of it. But there’s no great mystery as to the rest. JPMorgan’s analysts say the sell-off has simply overshot because of technical factors (ie levered long investors have been shaken out of positions).

The confluence of these events may have acted to catalyze the move, but we think the extent of the recent sell-off has now exceeded fundamentals. As we have noted over recent weeks, investor positioning in duration space had also been stretched to the long side, and unwinds of duration longs may have contributed to the move.

Basically, Treasuries were too expensive given the improving economy, sold off as investors even more data reinforced the ‘no-landing narrative’, and the sell-off then overshot a little because some people who had been long got smashed in the reversal.

Another popular theory making the rounds is that the strength of the dollar is forcing other central banks to dump Treasuries to support their own currencies. But JPMorgan is also sceptical that this has had any meaningful effect:

While the dollar has historically been a clear driver of foreign demand for Treasuries, this relationship appears to have weakened in the past year. Moreover, if there is indeed official selling of Treasuries, we are not sure there would be a pronounced impact on the long end — foreign official holdings of Treasuries tend to be concentrated at the front end of the curve, so they can be more easily liquidated in times of financial stress. Additionally, despite the chatter and the considerable moves in yields in the last couple of weeks, swap spreads have remained fairly stable. Overall, we don’t expect foreign official selling of Treasuries to be a meaningful driver of yields in the near-term, nor a significant negative for swap spreads.

Further reading
— About that Treasury ‘tsunami’ . . .