The yield on the 30-year Treasury bond briefly rose above 5% again on Friday, opening the door to the likelihood of a more sustainable rise above that mark and the risk that the benchmark 10-year yield follows — moves which could wreak havoc across financial markets.
One big reason is that investors are likely to demand greater compensation for taking risk as yields hover around some of the highest levels of the past 16 years, asset managers said. Corporate credit spreads could keep widening in a sign of worsening economic conditions and higher overall risk. And with returns on government debt becoming a more favorable option for investments, the stock market may be vulnerable to repeated drubbings.
Stock investors nonetheless shook off Friday’s stunning official jobs report for September, which saw the U.S. add almost twice as many jobs as forecasters had expected. All three major stock indexes
DJIA
COMP
finished higher even though yields climbed on everything from the 1-month T-bill
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to the 30-year bond
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The yield on the long bond finished at 4.941% — the highest level since Sept. 20, 2007 — after rising past 5% during the New York morning. The rate on the 10-year note
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ended at 4.783%, the second-highest level of this year.
Yields are returning to more normal-looking levels that prevailed before the 2007-2009 recession as the result of aggressive selloffs in government debt. More important than the absolute level of yields is the speed with which they have been heading to 5%. In the words of analyst Ajay Rajadhyaksha of Barclays earlier this week, there’s “no magic level” that will turn the current selloffs into a rally, and stocks have substantial room to reprice lower before bonds stabilize.
“I think the market isn’t breaking yet, but a 5% 10-year yield is coming,” said Robert Daly, who manages $4.5 billion in assets as director of fixed income at Glenmede Investment Management in Philadelphia. “We’re already here on 30s and not that far away on 10s. Investors are trying to figure what level breaks the market, and I don’t think you can put your finger on the pulse as to what that level is.”
Still, “a higher level of interest rates and yields is going to start having ramifications for broader markets at large,” leaving many investors hesitant to buy just about anything due to the volatility, Daly said via phone on Friday, after the release of September’s hot payrolls data.
Friday’s data, which showed the U.S. creating 336,000 new jobs last month or almost double what economists had expected, is opening the door to a possible interest rate hike by the Federal Reserve on Nov. 1. The strong labor market means the Fed’s higher-for-longer mantra in rates is still in play and “the market is in a tenuous position to navigate all these things because of all the uncertainty,” Daly said.
“Yields sustainably above 5% for a longer period of time will act as a weight on the market in terms of how you value risk compensation,” he said. “Investors are going to ask for more compensation to take risk and when you see liquidity evaporate more and more, that’s what’s going to turn the market over.”
Friday’s price action was the second time this week that data related to the robust U.S. labor market has triggered a bonds selloff. On Tuesday, a snapback in U.S. job openings for August sent the 10- and 30-year yields to their highest closing levels since August-September of 2007.
The next day, high-grade corporate-credit spreads widened for a seventh consecutive session. Daniel Krieter, a fixed-income strategist at BMO Capital Markets, wrote that “if rates continue to move higher or simply remain at these elevated levels for a significant period of time, it is going to have a pronounced effect on the creditworthiness of corporate borrowers, particularly in the high yield space.”
In a note on Friday, Krieter’s colleagues, rates strategists Ian Lyngen and Ben Jeffery, wrote that “it’s not difficult to envision 10s maintain a range between 4.75% and 5.00%.”
“The longer 10s hold this range, the more convinced the market will become that elevated yields are here to stay,” Lyngen and Jeffery said. “Admittedly, we’ve been surprised by the muted response in U.S. equities from the spike in yields and expect that’s due in part to the expectation for a swift reversal. In the event a correction fails to materialize, stocks will be overdue for a more meaningful reckoning.”
The risk of “something breaking” will remain top of mind and “there is no shortage of risks facing equities and credit as rates continue to climb,” they added. “It’s not only the outright level of yields, but the length of time that borrowing costs stay elevated will also hold implications for risk asset valuations.”
