The Speed of Yields

Macro Perspectives: Thu 4 Mar 2021

At the highs of last week, the ten-year U.S. Treasury yield had nearly doubled since the beginning of the year (in two months). 

The Fed Funds Rate (the target rate which is set by the Fed) hasn't moved - but the market interest rate (the rate determined by market participants) nearly doubled. 

This is creating concern for markets and the Fed - not that the economy is too fragile to survive on a 10-year interest rate of less than 1.5% - the idea that rates have moved fast, and may continue to rise, and to rise fast. That would be trouble.

Aside from the abrupt slowdown effect it would have on the economic recovery, it would represent either 1) a market that thinks the Fed has it very wrong on the inflation outlook, or 2) a market that is taking the cue of recklessly extravagant U.S. government spending, and political and social instability, to dump their long-term investments in the Treasury market (the historically safest and most liquid investments in the world).

Or it could mean both and both may be right. But the Fed has been in control of the bond market and recent history (the past 12 or so years) suggest that they will maintain control of the bond market. That means, we should expect the Fed to respond to this sharp rise in market interest rates. We've already heard them try (no no effect) to talk it down, with promises of keeping rates low, and assurances that they see little-to-no inflation risks.

Now there is speculation that the Fed will revisit the "Operation Twist" strategy they did in 2011; selling short dated Treasuries and buying longer dated Treasuries. This flattens the yield curve, bringing down longer term rates (without having to buy more bonds... i.e.without having to increase the money supply).

Let's take a look at what happened to stocks when they did this in 2011.

Stocks were in bear market territory, due to an unraveling European debt crisis at the time. Following the Fed's actions, stocks continued to fall another 7%, but bottomed within a couple of weeks.

With the 10-year trading at 1.47% today, the Treasury market continues to be the spot to watch.