SYDNEY — The yield on 10-year US Treasury bonds climbed above 2.4% on Tuesday night — their highest level since early May — and markets may still be at risk of complacency about the prospect of rising interest rates.
US 10-years have risen by around 10 basis points over the past week, after the US Senate passed a budget resolution which helped clear the way for the Trump administration to enact tax cuts. Here’s the chart:
US 10-year bonds are seen as the benchmark guide for the direction of global interest rates. Bond yields move inversely to their price, so a rise in yields indicates a sell-off in bond markets.
This week’s move in yields may also reflect the bond market’s assessment that the global growth picture is becoming more entrenched after almost a decade of low interest rates.
Global manufacturing data would appear to support that, with the composite PMI readings prepared by IHS Markit for the month of September at their highest level since April 2015. The data is based on a survey of over 18,000 firms from 40 countries, which account for around 90% of global gross domestic product (GDP).
From a technical standpoint, Greg McKenna from AxiTrader said the 2.4% mark for US 10-year bonds represents a key resistance level, and a break higher would see a move towards 2.6% in play.
“Bond rates rising is something to watch across the globe. It’s my sense markets are far too complacent of this possibility and also the chances for a return of inflation over the next year,” McKenna said.
Bond investor Jeff Gundlach, the Chief Investment Officer at DoubleLine Capital, took to Twitter this morning to pronounce that if US 10-year notes didn’t see quick demand it will be a clear sign that the bull market for bonds is over.
If yields do continue to climb, the impact is likely to be felt across assets classes including stocks and currencies, but so far markets have shown no sign of any changes.
US stocks have shrugged off the rise in yields this week, with the Dow Jones climbing to yet another record high overnight.
From a stocks perspective, share markets typically benefit from a low interest rate environment, as yield-seeking capital moves out of debt and into equities.
Stocks have so far been supported by more strong results in Q3, while a prospective cut in the corporate tax rate is likely to boost the growth outlook for sections of the market.
And while the US dollar index has consolidated from its September lows, at a reading of just below 94 it remains well off its highs from December 2016 when optimism around the “Trump trade” reached its peak.
As the yields on US 10-year notes have been climbing, shorter-term 2-year bond yields have risen even faster.
2-year bond yields are more sensitive to the short-term direction of interest rates, and the US Federal Reserve remains on track to raise rates for the second time this year in December.
Although the potential impact of rising rates is yet to be felt across different asset classes, Capital Economics economist John Higgins said the risk of a recession is low in the medium term.
Higgins said the flattening yield curve between 2-year and 10-year bonds, from around 125 basis points at the start of the year into 75 basis points, had some analysts raising the risk of a pending economic recession.
“This is because the last time that it was so flat was just before the financial crisis,” Higgins said.
However, prior to the financial crisis and in the two recessions before that, the yield curve had actually turned negative:
“The fact that the curve has not inverted in recent years suggests to us that another recession is not around the corner,” Higgins said.
“We don’t expect the yield curve to invert until after the Fed has raised its target for the federal funds rate to a peak of 2.50- 2.75% in the spring of 2019, where we expect it to be kept for the rest of that year.”
For now, the near-term direction of US bond yields will be driven primarily by the outcome of US tax reforms, according to Scott Minerd, the global investment chief at Guggenheim partners.
Minerd said on Twitter that the potential impact of tax cuts on global markets “can’t be overstated”, adding that tax stimulus will “force the hand” of the US Federal Reserve in its current rate tightening cycle.