US Treasury market hit by a renewed round of selling

Sharply rising European government yields underscore the growing hawkish chorus

The US Treasury market was hit by a renewed round of selling as sharply rising European government yields underscored the growing hawkish chorus among the world’s major central banks in the face of surging inflation.

The drop in Treasuries extended global bond losses Thursday, when benchmark UK and German 10-year yields jumped more than 10 basis points after the Bank of England and the European Central Bank held policy meetings and signalled patent unease about elevated inflation pressure.

The German 10-year yield, which had been below zero until this week, jumped to around 0.15 per cent, weakening what had been an anchor on Treasury yields as European investors shifted money to the US to get positive returns.

That renewed selling pressure swept across the US bond market, where the 10-year Treasury yield rose as much as 7 basis points to 1.85 per cent. The 30-year yield also rose as much as 7 basis points to 2.18 per cent.


A sustained rise above zero for the German bund is seen paving the way for a test of 2 per cent and higher in the 10-year Treasury.

“There is no question that all central banks realise they are behind the curve due to higher inflation and bond markets have woken up to that,” said William O’Donnell, strategist at Citigroup Inc.

“The U.K started the selling in Treasuries and then it was followed by bund yields moving higher.”

The drop adds to what has already been a painful year for bondholders, with the hawskish pivot from Federal Reserve driving the Bloomberg Treasury index to loss of 1.9 per cent in January, its worst since late 2009.

Prices had largely settled since late last month, however, with traders wagering that the market had adjusted to the coming monetary policy shift by pricing in five quarter-point hikes from the Fed this year.

Confidence had also been bolstered by the solid demand at recent auctions for Treasuries, whose relatively higher yields have been a draw for foreign investors.

But a more sustained rise in long-dated global yields worldwide amid growing unease about global inflation pressure is challenging that outlook and may weigh further on sentiment for Treasuries.

The Bank of England’s hawkish tone “has served as a reminder that global markets are pushing for higher policy rates and that will be this year’s theme,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets.

“London, Frankfurt, and Washington are now all in decidedly hawkish stances and it follows intuitively that there would be a bearish impetus in Treasuries.”

At about 1.36 per cent, the 10-year Gilt yield has climbed to its highest level in over two years, with the Bank of England raising its overnight rate to 0.5 per cent and announcing it will start reducing its balance sheet holdings by ceasing to reinvest maturing assets and by selling its holdings of corporate bonds.

While the European Central Bank left policy on hold, officials expressed concern about elevated inflation, helping to intensify this week’s drive of Germany’s 10-year yield above zero for the first time since May 2019.

The rise in global benchmark yields, including in Japan, is reducing the pool of global negative yielding debt, removing another source of Treasury-market support.

The amount of sub-zero yielding bonds has declined to $7.67 trillion, according to a Bloomberg index, the least since 2018 and down from a peak of $18.38 trillion seen in late 2020.

Citigroup’s O’Donnell said a US 30-year bond yield around 2.17 per cent is at the lower of a range seen before the pandemic arrived.

“If the selling pressure in UK and European markets continues, I would expect the 30-year bond spends more time in the 2.17 per cent to 2.45 per cent area,” he said. “Our core thesis for this year is that real rates are going up.”

With a lengthy window until the next Federal Open Market Committee meeting in March, the Treasury market is looking for further signals for how rapidly the central bank will move, including its plans for shrinking its balance sheet in conjunction with raising rates.

Fed chair Jerome Powell has said he will take a nimble approach, which has promised to inject more volatility into the Treasury market as new economic data is released, including the monthly jobs report on Friday.

“The next couple of months are going to see higher inflation prints that leaves the market dealing with Fed policy uncertainty,” said Rick Rieder, chief investment officer of global fixed income at BlackRock Inc.

A slowing economy and moderating inflation represent a base case for the asset manager this year and Rieder expects the 10-year will be challenged to rise beyond 2 to 2.25 per cent.

“The international bid for Treasuries is not going away, with the ECB and Bank of Japan moving much slower than the Fed”. – Bloomberg