The US government bond market experienced its most challenging day since March 2020, as higher-than-expected inflation data for September and lackluster demand for a bond auction led to a surge in 30-year yields.
The 30-year Treasury yield soared by as much as 19 basis points and was up 16 basis points by the end of the day’s trading, marking its most significant increase since the market turmoil triggered by the onset of the pandemic. Although it stands at 4.86%, nearly 20 basis points below the multiyear highs observed last week, this sharp rise has fueled concerns about the potential for new milestones, such as a 5% yield for 10-year Treasury notes.
Yields across the entire spectrum of Treasuries rose by at least 9 basis points by the end of the trading day, with the 10-year yield increasing by 14 basis points to 4.70%. The disappointing results of the 30-year bond auction followed similar trends seen in the sales of three- and 10-year notes earlier in the week. This combination has heightened apprehensions about the interest rates investors will demand as auction sizes increase and a robust economy encourages risk-taking.
According to TD Securities strategists Gennadiy Goldberg and Molly McGown, the 30-year auction “appears to have further destabilized sentiment.” They added, “Worries about a lack of demand for Treasuries could allow rates to re-test recent highs, with 10-year yields potentially approaching the 5% mark,” last seen in 2007.
The strategists adjusted their forecasts for Federal Reserve policy and Treasury yields, now predicting a later start to a smaller total number of rate cuts, and higher yields than previously expected. These revisions are based on their belief in the “resilience of the US economy.”
The bond market’s turbulence on Thursday began following the release of Labor Department data showing that consumer prices rose by 0.4% in September, maintaining the year-on-year rate at 3.7%. This figure exceeded economists’ median estimate of a 0.3% increase and a 3.6% annual rate.
The inflation data prompted traders to increase their expectations for another interest-rate increase by the Federal Reserve this year. Swap contracts linked to future Fed rate decisions raised the odds of a quarter-point increase to approximately 40%, up from around 30% on Wednesday.
Mustafa Chowdhury, Chief Rates Strategist at Macro Hive Ltd, commented, “I think we have moved back into a twilight zone regarding the end of the Fed cycle.” He believes that inflation is unlikely to decline as smoothly as Fed policymakers have predicted, and that “sooner or later they will have to restart hiking.”
Rates on swaps based on the Fed’s policy rate also increased, reflecting about 11 basis points of tightening for December, equivalent to roughly 40% of a quarter-point hike. For most contracts expiring in 2024, rates increased by 7 to 10 basis points, indicating reduced odds of rate cuts.
Inflation-protected Treasuries outperformed as investors considered the possibility of consumer price growth continuing to outpace expectations. The widening gaps between lower real and higher nominal Treasury yields indicate the inflation rates needed to equalize their returns.
For five-year securities, the breakeven inflation rate increased by about 4 basis points to 2.24%. It remains close to the lower end of its range since early 2021, prior to the acceleration of price growth. This suggests that investors expect the Fed to be successful in curbing inflation.
The auction was awarded at 4.837%, almost 4 basis points higher than its yield in pre-auction trading at the bidding deadline. This indicates that demand fell short of dealers’ expectations, despite it being the highest-yielding 30-year auction since 2007.
Michael Contopoulos, Head of Fixed Income at Richard Bernstein Advisors, advised caution, stating, “I don’t think now is the time to take on a heroic stance and add a lot of duration.” He believes that with the Fed slowing the pace of tightening, “the economy and inflation are being given a chance to pick up, and that’s detrimental for longer-term yields.”
