Bond Slide Deepens, With No End in Sight
10-year Treasury yield settles at highest level since 2011 amid uncertainty over how high the Fed will have to raise rates
The sharp investor retreat from government bonds in recent days reflects deepening gloom over the outlook for markets in the wake of Friday’s surprisingly hot inflation report.
Rocked by data showing a broadening increase in consumer prices, bonds slid sharply on Friday and then again Monday and Tuesday, pushing yields on U.S. Treasurys—which rise when prices fall—to their highest levels in more than a decade.
Heading into Friday, there was widespread hope on Wall Street that bond yields had finally reached the peak of this year’s climb, having done enough to tighten financial conditions that consumer demand and inflation could gradually return to more sustainable levels. Now, many say they have little idea how high the Federal Reserve will have to raise short-term interest rates to wrest control of prices, which are currently rising at a rate several times higher than the central bank’s 2% annual target.
“There is definitely an element of capitulation,” in the bond market’s move, said Thomas Simons, senior vice president and money-market economist in the Fixed Income Group at Jefferies LLC. “There is a general acknowledgment that Friday’s data was a profound message.”
Yields on Treasurys largely reflect investors’ expectations for short-term rates over the life of a bond, and they in turn set a floor on borrowing costs across the economy. On Tuesday, the yield on the benchmark 10-year U.S. Treasury note settled at 3.482%, its highest close since April 2011.
The yield has climbed 0.513 percentage point over the last five trading sessions, the largest gain over that span since Oct. 2008.
The two-year yield, more sensitive to the near-term outlook for monetary policy, settled at 3.435%, the highest since November 2017 and up from 2.815% Thursday.
Shorter-term yields in particular got a boost late Monday after The Wall Street Journal reported that the Fed could raise short-term rates by 0.75 percentage point at is policy meeting that ends Wednesday—an aggressive step it hasn’t taken since 1994 and an escalation from the half-a-percentage point increase it delivered at its May 3-4 meeting.
The potential shift in policy followed Friday’s consumer-price-index data, which could hardly have been more dispiriting, according to investors and analysts. Not only did headline inflation reach a four-decade high at a point when many investors had expected it to be coming down, but there were substantial price increases across the board, in everything from housing costs to children’s footwear.
Investors, therefore, couldn’t blame the report on any one category, as some had done the previous month when surging airline costs played a large role in driving up a closely watched measure of inflation that excludes volatile food and energy costs.
Delivering another blow to Treasurys, data released just an hour and a half after the CPI report showed consumers’ long-term inflation expectations rising to their highest level since 2008. That hurt the argument that anchored inflation expectations would help keep a lid on actual inflation.
“The reality is that we’re not seeing sufficient signs that things are slowing down,” said Daniela Mardarovici, co-head of multisector fixed income at Macquarie Asset Management, referring to the level of economic activity and inflation.
The result, she added, is that investors have had to increase their estimate for the so-called neutral level of interest rates that neither stimulates nor slows economic growth. That, in turn, has pushed up both short- and longer-term U.S. Treasury yields. The two-year yield briefly surpassed the 10-year yield in after-hours trading Monday, sending what is often considered to be a warning sign about the economic outlook.
Treasury yields play a critical role in both the economy and financial markets. Their rise this year has helped push the average 30-year fixed mortgage rate above 5% for the first time in more than a decade. They have also dragged down stock prices, increasing the opportunity cost in foregoing bonds for equities and delivering a particularly heavy blow to relatively unprofitable companies valued for their longer-term earnings potential.
Bonds themselves have suffered heavy losses this year as a result of price declines, with major bond indexes easily on pace for their worst year on record.
As of Monday, the Bloomberg U.S. Aggregate bond index—largely U.S. Treasurys, highly rated corporate bonds and mortgage-backed securities—had returned minus 12% this year. Its second-worst performance over the same period was minus 2.9% in 1984, in records going back to 1976.
Many investors and analysts still believe that the worst is likely over for bonds, pointing to slowing housing demand and plunging consumer confidence as signs that higher interest rates are already having their intended effect of cooling the economy.
Still, others warn that the poor performance of bonds could even create its own negative momentum.
“Perhaps the biggest risk for higher rates is that investors just decide to sell bonds,” said Donald Ellenberger, a senior fixed-income portfolio manager at Federated Hermes. “If investors decide that bonds aren’t doing a very good job hedging stocks and still aren’t paying much income, we could see rates spike higher because Wall Street dealers don’t have the balance-sheet capacity or desire to warehouse bonds nobody wants.”
US Economy Has "Decent Chance" Of Avoiding Recession But Things "Could Go Bad": Bernanke
Federal Reserve officials have a “decent chance” of avoiding a recession in the United States with a “soft landing,” former Federal Reserve Chair Ben Bernanke said on Sunday.
“The U.S. economy today is a mixed bag,” Bernanke said on CNN’s “Fareed Zakaria GPS” while noting inflation levels that have reached 40-year highs.“A recession is possible. Economists are very bad at predicting recessions, but I think the Fed has a decent chance, a reasonable chance of achieving what [Fed Chair] Jay Powell calls a ‘soft-ish landing;’ either no recession or a very mild recession to bring inflation down,” he added.
Bernanke pointed to a strong labor market in the United States, saying that “with some luck, and if the supply side improves, the Fed can get inflation down without imposing the kind of costs we saw in the early ’80s.”
The former Fed chair also noted that the central bank “knows it is responsible” for inflation and will take the lead in bringing it down, citing its political support from President Joe Biden and lawmakers in Congress.
Bernanke did, however, note that “some things could go wrong” and said he was counting on the supply chain crisis to improve, adding that there is already “some evidence” that it is.
“I’m hoping and guessing that oil and food prices will at least stabilize and preferably begin to moderate,” he said, while acknowledging that “things could go bad” if the above does not go to plan and inflation persists, leading Americans to start losing confidence in the central bank.“Then the Fed might have to crack down much harder,” Bernanke said.
Bernanke’s comments come as experts have sounded the alarm on a potential full-blown recession in the United States, despite the Biden administration insisting that inflation is a “top economic priority.”
U.S. annual inflation rate surged to 8.6 percent in May, prompting Biden to tell reporters at a White House press briefing on June 10 that his administration will “continue to do everything we can to lower prices for the American people” while calling on Congress to act fast in passing legislation to cut shipping costs and prices for families for things like energy bills and prescription drugs.
Morgan Stanley projects (pdf) a 27 percent chance of a recession in the next 12 months, up from 5 percent in March, while a recent Bloomberg monthly survey of economists found that the probability of a recession over the next 12 months is 30 percent, the highest since 2020.
In contrast, Goldman Sachs economists said earlier this month that improved inflation figures and adjustments to the jobs market have reduced the risk that the Federal Reserve will have to aggressively raise interest rates to the point that it could force the country into a downturn.
Crypto Legislation Could Undermine Market Regulations, Gensler Says
SEC Chairman says recent proposal could impact broader $100 trillion capital market
WASHINGTON—Securities and Exchange Commission Chairman Gary Gensler expressed concern Tuesday that efforts in Congress to write legislation for the cryptocurrency industry could compromise regulations that govern the broader capital markets.
Asked about a bill introduced last week by Sens. Cynthia Lummis (R., Wyo.) and Kirsten Gillibrand (D., N.Y.), Mr. Gensler initially demurred, saying he would prefer to discuss the proposed legislation with the senators. But he then suggested that legislative changes targeting cryptocurrencies could have implications for stock exchanges or mutual funds.
“We don’t want to undermine the protections we have in a $100 trillion capital market,” Mr. Gensler said at The Wall Street Journal’s CFO Network Summit. “Like behaviors should have like treatment.”
WASHINGTON—Securities and Exchange Commission Chairman Gary Gensler expressed concern Tuesday that efforts in Congress to write legislation for the cryptocurrency industry could compromise regulations that govern the broader capital markets.
Asked about a bill introduced last week by Sens. Cynthia Lummis (R., Wyo.) and Kirsten Gillibrand (D., N.Y.), Mr. Gensler initially demurred, saying he would prefer to discuss the proposed legislation with the senators. But he then suggested that legislative changes targeting cryptocurrencies could have implications for stock exchanges or mutual funds.
“We don’t want to undermine the protections we have in a $100 trillion capital market,” Mr. Gensler said at The Wall Street Journal’s CFO Network Summit. “Like behaviors should have like treatment.”
“We’re not looking to extend our jurisdiction,” Mr. Gensler said. “But these tokens are being offered to the public, and the public is hoping for a better future. That’s the characteristics of an investment contract,” a type of security.
Mr. Gensler’s remarks contrast with those of his counterpart at the SEC’s sister regulator, the Commodity Futures Trading Commission, which would gain significant authority under the Lummis-Gillibrand bill.
At an event last week, CFTC Chairman Rostin Behnam said the proposed legislation “does a very good job” of clarifying the distinction between securities and non-securities in the crypto market and in empowering the CFTC to police the latter category of assets.
Atos: from roll-up to blow-up as IT group gropes for reboot switch
Any investor joining this rescue mission may end up floundering
Atos enjoyed years of acquisition-fuelled growth. Flaws in the French IT group’s roll-up strategy began appearing after an ambitious bid failed in early 2021. Even so, investors are shocked by the news chief executive Rodolphe Belmer is leaving amid a restructuring. The shares, down by three-quarters since January 2021, fell another 23 per cent on Tuesday.
Belmer is apparently departing after falling out with other board members over a spin-off. The disagreement left the ex-Eutelsat boss, who started only in January, ill-placed to sell the merits of the turnround plan underpinned by the transaction.
There is a logic in demerging a profitable big data and cyber security division. That should stop it being dragged down by the legacy IT services business. This is suffering from problematic legacy contracts and IT budgets shifting to cloud investment.
Atos reckons IT services will cost €1.1bn to turn round. The unit is only expected to start making operating profits in 2025. Investors will attribute little value to it.
The big data and cyber security business operates in fast-growing markets and is worth more. Atos reckons free cash flow, before interest and tax, could grow nearly fivefold to €700mn by 2026.
Assume, generously, that the company meets its targets. Applying a 7 per cent free cash flow yield and deducting €400mn of planned investment, implies a value of as much as €3.5bn for Atos investors who would get 70 per cent of it. The remainder would be held by the rump company to fund the turnround.
Investors should be more sceptical. Atos needs €1.6bn in funding for 2021-22, after taking account of debt repayments and planned asset sales. This sum is now bigger than the market value. Given its weak cash flows, there is a risk net debts will rise sharply. That would breach a debt covenant, according to Citi.
Atos insists there is no risk of this, so no need to raise more capital. But the management team is untested. Any investor joining this rescue mission may themselves end up floundering.