The Treasurys Market Is Getting Squeezed From All Sides
Inflation and deficits are lifting yields and jarring the stock market
Pressure keeps building in the bond market.
Stickier-than-expected inflation this year has boosted yields on U.S. debt enough to dent the stock-market rally. Soaring spending by Washington shows few signs of slowing. And the latest plan to finance it all promises a flood of Treasurys in the coming months that will need to find buyers.
Those factors are forcing investors to ditch some of their optimism from early this year and reopen their playbooks for a world of higher yields. With the Federal Reserve on Wednesday signaling it has the stomach to keep interest rates elevated to tame price pressures, many worry the pain will continue for some time.
Wall Street’s shift in outlook has fueled a bond selloff, propelling the yield on the benchmark 10-year Treasury note in April to its steepest one-month gain since September 2022. A rally Wednesday helped drag down the 10-year yield to 4.591% but some of those gains reversed in after-hours trading. While the yield remains below last year’s peak of around 5%, it is still near two-decade highs.
Yields rise when bond prices fall. Yields’ recent ascent has helped pull stocks back from records, cutting into the extra return investors receive for the added risk of holding equities instead of bonds and eroding the present value Wall Street assigns to companies’ future profits.
All three major indexes have fallen at least 4% over the past month, with declines ranging from high-growth tech companies to firms prized for steady dividends. The Russell 2000 index of smaller businesses has dropped even faster.
“That tells me investors are starting to get more defensive on equities and the economy in general,” said John Mousseau, chief executive officer of the investment firm Cumberland Advisors.
The shift stems largely from a U.S. economy that has defied expectations by creating jobs, bumping up wages and buoying Americans’ ability to spend despite higher borrowing costs. On Wednesday, the Fed said it would keep holding rates steady at 23-year highs, noting “a lack of further progress” in recent months toward getting inflation down to the central bank’s 2% target.
“We think our policy stance is appropriate to do that,” Fed Chair Jerome Powell said.
While it remains unclear how long it will be before the central bank weighs rate cuts, “it’s unlikely that the next policy rate move will be a hike,” Powell said.
That caution represents a reversal from early this year, when some investors expected as many as a half-dozen interest-rate cuts in 2024. Now, futures markets are pricing in a roughly 20% chance the Fed will hold rates steady through the end of the year, according to CME Group, up from just 2% a month ago.
More arcane factors have also added to the uncertainty. The government funds spending on Social Security, the military and other areas in part by selling bonds at regular auctions. As Washington has run up larger budget deficits in the wake of the pandemic, those auctions have ballooned, drawing warnings that Wall Street may struggle to absorb the debt.
Few investors fear a failed auction, an unlikely scenario that could potentially trigger prolonged market turmoil. Still, many worry that tepid demand could rattle markets and hurt the economy. Those fears intensified after a series of weak auctions this past month drove Treasury yields higher. Demand improved somewhat at recent auctions. But more outsize issuance is coming soon.
The Treasury Department said Wednesday that it would sell roughly $1 trillion of bonds in total from May to July, keeping its auction sizes steady. The plan maintains an approach started after weak auctions late last year, when Treasury eased market pressures by shifting issuance toward short-term debt. At the time, the Fed also signaled a pivot toward easier monetary policy, with hopes for imminent rate cuts reassuring investors about the strategy.
Now rates may stay higher for some time, and the nonpartisan Congressional Budget Office forecasts the deficit will grow from 5.6% of U.S. gross domestic product to 6.1% in the next decade. Public debt is set to expand to $48 trillion from $28 trillion over that period. Few investors expect either party will push to drastically cut spending after the November election.
Yields held steady after the Treasury’s announcement Wednesday, with investors saying it was widely expected. But Treasury also said that it likely wouldn’t have to increase auction sizes for “at least the next several quarters,” a longer period than some analysts anticipated.
Leah Traub, a portfolio manager at Lord Abbett, said the coming waves of bond supply may create short-term volatility that ripples across markets. The results of last week’s auctions gave “no indication that demand [for Treasurys] is waning or growing,” she said.
The coming slate of auctions will also veer toward Treasurys maturing in less than 10 years. That makes the federal government’s future interest-rate expenses harder to predict, said Brian Jacobsen, chief economist at Annex Wealth Management.
But the bias toward shorter-dated securities also reflects many investors’ growing wariness of making bets on the long-term trajectory of U.S. monetary policy.
“In the past, the Fed hiked slowly and cut aggressively, but this time they hiked aggressively and will likely cut gradually,” said Jacobsen. “That isn’t lighting a fire under investors to get out of cash and into longer-term bonds.”
One force that could ease the strain: The Fed on Wednesday also said it would slow the pace at which it is reducing its bondholdings, which it had grown during the pandemic in an attempt to boost the economy. That, on the margin, should reduce pressure on the Treasury to issue bonds to investors because the central bank will need to buy more new Treasurys to keep its holdings from shrinking too quickly as some of its older bonds mature.
Some investors remain skeptical that the recent yield climb is being driven by bigger auctions, greater public spending or the onset of an era of higher interest rates.
Blake Gwinn, head of U.S. rate strategy RBC Capital Markets, said the recent Treasury selloff is rooted more in first-quarter data showing that the labor market remains tight and price pressures persist in parts of the economy.
“I don’t think what we’ve seen postpandemic suggests some new paradigm,” he said. “I think we’re just kind of getting back to normal.”