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Investment

Many forces are in place that could keep pushing rates even higher

A turbulent bond market sell-off on Tuesday sent interest rates to new multiyear highs, and signals the potential for a new trend that will push borrowing costs even higher on a wide range of business and consumer loans and mortgages.

The selling was sparked by stronger economic data, but the market has been itching for a move higher in yields, which rise as bond prices fall. The benchmark 10-year yield ripped above 3 percent and was near a seven-year high of 3.07 percent in midday trading. Mortgage rates are also at a seven-year high.

Tuesday’s report on April retail sales was basically in line with expectations with a 0.3 percent gain. But revisions to March retail sales data showed spending was up 0.8 percent, from 0.5 percent, and that relieved some concern about the strength of the consumer. The Empire State survey also showed manufacturing activity in New York was better than expected.

Strategists say the reports were the immediate catalyst, but they also point to the fact that the U.S. has a massive amount of debt to sell this year, and foreign buyers are not showing the same appetite they once had. At the same time, the Fed is set to raise interest rates two more times this year, and the market is increasingly pricing in a third hike.

Yields moved higher Tuesday along the entire Treasury yield curve from 2-year notes to 30-year bonds, but the widely watched 10-year made a significant move and appears to have broken into a new trend. The 10-year hit a high of about 3.069 percent, up from 2.995 percent Monday. That new level may now mean the 10-year yield could hold above the psychological 3 percent mark.

“It appears to be definitively broken through 3 percent. We’ve tested it a couple times. It seems like we’re pretty well north of that level. … Seeing this is not a surprise, but the speed at which we’ve gotten above 3 percent is notable,” said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch. “The catalyst obviously is this morning’s data. While it was encouraging, the move seems outsized relative to the surprise, which suggests there are positioning factors at play.”

Earlier this month, the Treasury Department expanded the size of Treasury auctions and it is expected to do so again this year to meet its obligations as the federal deficit balloons, due to massive tax cuts and stimulus spending. Last year, the government issued $540 billion in Treasurys, not including bills, and this year, that could approach $1 trillion.

“We just got a very daunting supply backdrop in the U.S. Some of the more stalwart buyers, particularly some of the foreign private investors, are not as robust as they had been in prior years. In that environment, it has allowed rates to press higher,” said Cabana. He expects to see a 3.25 percent 10-year by year-end, while other forecasts are at 3.50 percent with some even as high as 4 percent.

The 10-year first reclaimed the 3 percent level in April and has been flirting with that milepost ever since. But on Tuesday, it succeeded in definitively smashing through that level, hitting the highest rate since the summer of 2011 — in the months before the U.S. debt rating was downgraded and Congress was embroiled in a debt ceiling battle.

Stocks sold off sharply amid concerns about the jump in rates, and the Dow was down nearly 1 percent in early afternoon trading, regaining some lost ground.

Higher yields have been already impacting mortgages with the 30-year fixed rate mortgage rate likely to end Tuesday at about 4.875 percent for the best credit-worthy borrowers and 5 percent for the average borrower, according to Mortgage News Daily.

About half of Tuesday’s move in Treasury yields can be attributed to the data and a sell-off overseas that spilled over to the U.S., said Michael Schumacher, director rates strategy at Wells Fargo. But the rest of the move was hard to explain fundamentally.

“I think it’s important to get above 3 percent and show some upward momentum,” said Schumacher. “I’m not hung up on whether it’s 3.03, 3.04, or 3.05 but it’s a pretty sizable move and that’s important.” Schumacher said lots of buyers seem to be lined up at 3 percent but it isn’t clear whether they are there for 3.04 or 3.05 percent.

“There’s a big technical element here. I’m not going to dismiss retail sales and some of the other data, but this is a technical move and a technical move always needs fundamental justification,” said David Ader, chief macro strategist at Informa Financial Intelligence.

The 2-year yield reached 2.577 percent Tuesday, its highest level since 2008. The 2-year is most reflective of the Fed tightening, and it moved higher with the entire yield curve.

“A new trend is developing and that’s towards higher rates,” said Andrew Brenner of National Alliance Securities. But he said for the trend to be confirmed, the 30-year bond needs to see its yield move toward 3.25 percent. The long bond was yielding about 3.19 percent Tuesday.

“What you need to actually call it a bear market, or bear trend, you really need confirmation with the long end,” he said. “If you were to close above 3.05 that would start the trend, but we’ve seen these fakeouts before. You don’t really have confirmation until you solidly break 3.22 (on 30-year).”

Tuesday’s big bond move managed to steepen the yield curve, meaning yields like the 2-year versus 10-year got wider apart. They had been flattening, and the 2-year and 10-year yield are the closest together they’ve been since 2007. That flat curve could be a sign of worry about the economy, and an inverted curve, where the 2-year would actually rise above the 10-year, is viewed as a reliable indicator of recession.

Some strategists say the curve flattening is a result of the Fed raising rates, pushing the 2-year higher, but demand for longer-dated bonds keeps down the 10-year. But there are also other factors that could affect it, like tame inflation.

“It’s telling us the market is not getting overly concerned about inflation. … Yes we had this technical breakout and maybe we can price a little more of the Fed which is going to lift all rates, but still this steepening to me is very corrective. The flattening is continuing to tell you inflation and much faster growth are not in the cards for the bond market,” said Ader. “It’s more accommodation for the increased auction size, but it’s not a story of growth and inflation.”

Source: Investment Cnbc
Many forces are in place that could keep pushing rates even higher

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