Why The US Treasury Market Has Been Getting Smashed

U.S. Treasury bonds are the biggest safe-haven investment on the globe. Treasuries are how the U.S. borrows money, and since the U.S. has its own currency, the prospect of a default on those bonds is viewed as a virtual impossibility.

So when times get bad, investors tend to pile into Treasuries, driving prices up and bond yields down. When times get good, people feel less inclined to be in safe-haven assets, and yields go up.

The yield on the 10-year Treasury bond bottomed out in July 2012, and since then, it’s been a steady grind higher – up until a few weeks ago, when things really started getting going and yields surged upward.

10 year treasury yield

Mid-way through last summer, the stock market was rebounding from a bit of a soft patch in the United States, and across the Atlantic, the euro crisis was perceived as the biggest risk to global markets as Spanish and Italian government bond yields were once again rising to levels that were making government borrowing costs unsustainable.

The first big change that shook up the status quo gripping global markets at the time and reversed the course of Treasury yields was European Central Bank President Mario Draghi’s now-famous speech in late July of last year in which he declared that the ECB was ready to “do whatever it takes to save the euro.”

Since then, the deteriorating economic situation in Europe has decoupled with stock and bond markets, which have been lifted by the threat of OMT, and the euro crisis is no longer viewed as much of a market risk.

The second reason bonds have sold off has been the improvement in economic data since last summer – especially relative to other major economies.

Perhaps the best illustration of this is perhaps a simple chart showing the growth gap that has emerged between the United States (the world’s largest economy) and the eurozone (the world’s second-largest economy).

GDP growth gap

The truth about the economic data and its effect on Treasuries is a little more nuanced than that, though.

In December, the Federal Reserve announced a significant policy change that has increased the sensitivity of Treasuries to U.S. economic data releases.

Treasury yields and macroeconomic data

The Fed said it would keep interest rates low in the U.S. economy at least until the unemployment rate fell to 6.5% and inflation reached 2.5%. That has caused the bond market to pay much closer attention to economic data releases, which have mostly been surprising to the upside of consensus forecasts over the past year or so.

And because the Fed has been buying up so many Treasury bonds since the financial crisis under its quantitative easing program – and now holds a significant portion of the entire market in its portfolio – perceptions about how long the Fed will continue buying are the biggest factor weighing on the market right now.

Investors rushed into bonds once again in March as the Cypriot financial crisis brought fears of a eurozone shockwave back to the fore, and concerns over a global slowdown began to resurface.

That rally lasted through early May, pushing Treasury yields down once again.

However, fears that the Fed will begin to taper its bond purchases soon have risen in a big way this month, capped by Federal Reserve Chairman Ben Bernanke’s failure last week to rebuff a suggestion during a testimony before the Joint Economic Committee of Congress that the central bank could begin reducing the pace of its bond purchases as soon as labour Day if the data warranted such action.

Given the optimism reflected in Wall Street forecasts for the U.S. economy, strategists are beginning to espouse the view that such tapering could come sooner than previously expected.

Goldman Sachs, for example, says the sell-off in the Treasury market is “for real” this time.

If the U.S. economic data continue to improve and cause investors to push further and further into risky investments – and the Fed actually does begin to tighten monetary policy stimulus – the “safe haven” appeal appeal of the U.S. Treasury market could continue to dissipate.

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