Source: Golden Ten Data

As concerns about US inflation intensify, some investors are preparing to welcome 10-year US Treasury yields of 5% higher than the 16-year high set in October last year.

Bond yields are the opposite of price movements. In recent weeks, signs of continued inflation have weakened expectations that the Federal Reserve will cut interest rates sharply without further boosting consumer prices, leading to a rise in bond yields. The benchmark 10-year Treasury yield rose 80 basis points to around 4.70% this year, hitting a five-month high.

Many investors believe that the bond market will weaken further in the future. Bank of America's latest global research survey shows that global fund managers' fixed income allocations have fallen to their lowest level since 2003. Bank of America data shows that despite additional bullish bets from other asset managers, some hedge funds' US Treasury short positions are still at their highest level this year.

Don Ellenberger (Don Ellenberger), senior portfolio manager at Federated Hermes, said, “At the end of the day, concerns about inflation are at play. If the market sees no sign that inflation is under control, then there's no reason why US Treasury yields won't continue to rise.” He has made his portfolio less sensitive to interest rates and is concerned that continued inflation and a strong labor market could push the 10-year US Treasury yield to 5.25%.

Data released on Thursday showed that the personal consumption expenditure (PCE) price index, excluding food and energy, rose far more than expected in the first quarter, further proof that inflation is heating up again. According to the futures market, investors currently expect the Federal Reserve to cut interest rates by only 35 basis points this year, compared to more than 150 basis points in early 2024.

PCE data for March will be released on Friday. If the data once again proves that inflation is picking up at that time, this may further close the window of expectations for interest rate cuts this year.

How much room is left for US Treasury yields to rise?

Market participants are closely watching US Treasury yield levels, as rising yields may mean higher borrowing costs for consumers and businesses, and tightening the financial situation of the economy.

In the second half of 2023, the sharp rise in US Treasury yields caused the S&P 500 Index (SPX) to be sold off, and when yields were reversed, the stock market also rebounded. Since this year, as yields have risen, the gains of US stocks at the beginning of the year have experienced a sharp decline in recent weeks. The increase in the S&P 500 index so far this year has shrunk from more than 10% to around 6%.

Some investors are taking advantage of the weakness in the bond market to increase their holdings of fixed income assets. They believe that unless the Federal Reserve says it will raise the benchmark interest rate again (currently 5.25%-5.50%), it is unlikely that the yield will rise further sharply. Others, however, are skeptical about whether inflation will continue to cool in the short term.

“Inflation has not declined as the Federal Reserve thought,” said Arthur Laffer, president of Laffer Tengler Investments. He is bearish on longer-term US Treasury bonds and believes that 10-year US Treasury yields may rise to 6%. “Taking risks in the bond market right now won't pay off.” he said.

Michael Purves (Michael Purves), head of Tallbacken Capital Advisors, wrote that if rising oil and other raw material prices continue to drive up inflation, then it is “not unimaginable” that the 10-year US Treasury yield reached a high of 5.22% since 2007.

Although the price of Brent crude oil fell somewhat last week as market concerns about the intensification of the conflict in the Middle East subsided, it has risen by about 17% so far this year.

America's fiscal position is another factor that may drive up yields. Rating agency Fitch downgraded America's credit rating last year, partly due to concerns about rising debt levels. Many investors expect the term premium (that is, the compensation required to hold long-term debt) to rise.

Bryant VanKronkhite, senior portfolio manager at Allspring Global Investments, said: “America's financial situation is starting to become more important, and if the market starts to become more concerned, it could put tremendous pressure on yields and depress stock valuations in a very short period of time.” He expects 10-year US Treasury yields to rise above 5%.

However, Alex Christensen, portfolio manager at Columbia Threadneedle Investments, said that there is reason to believe that a return of 5% to 10-year US Treasury yields will be a “watermark” for investors. Christensen holds two-year US Treasury bonds.

He said that since the Federal Reserve showed an obvious dovish shift in December last year, the dominant market rhetoric “has been very one-sided, leaving very little room for changes in the inflation trend.”

However, he believes it is unlikely that the Federal Reserve will switch to raising interest rates. “We think the overall inflation trend is steady downward,” he said.

edit/lambor