(Bloomberg) -- Since mid-September, the US Federal Reserve has cut benchmark interest rates by 100 basis points. Yet the yield on 30-year Treasury bonds has risen by around the same amount. This divergence between short- and long-term rates is counterintuitive and far from isolated, with UK 30-year yields hitting the highest since 1998 even as the Bank of England eases monetary policy.
The reason: Investors are worried that the inflationary pressures sparked by the pandemic will linger in the global economy for years. And what’s more, governments that spent heavily to stimulate economies during coronavirus lockdowns are still borrowing lots of money.
What’s special about longer-dated bonds?
Bonds issued by wealthy nations are widely regarded as the world’s safest securities, and none more so than US Treasuries. Many will look to lock in their financing for long periods such as 30 years, with some even issuing debt that matures in a century. While these bonds are often sought by longer-term investors, they are also generally more volatile.
That’s because they are more sensitive to inflation. Bonds fall when inflation accelerates because it reduces the purchasing power of the bonds’ interest payments. And inflation erodes the relative value of interest on 30-year bonds more than it does with shorter-dated Treasuries.
They may also be less easy to buy or sell, as a smaller cohort of investors is interested in them. They are often sought by institutions such as insurers and pension funds that need a fixed-income asset that generates cash flows to cover their liabilities, which can stretch over decades.
What’s the scale of the moves so far?
The $50 billion iShares 20+ Year Treasury Bond exchange-traded fund, which trades under the ticker TLT, is the world’s largest ETF focused solely on ultra-long US government debt. It has fallen by around 15% since mid-September, when the Fed began cutting interest rates. While that’s sizable, it pales in comparison with the 52% decline between a high in 2020 and October 2023. That was its largest ever selloff, fueled by surging inflation the world over that prompted central banks to raise rates. What’s interesting about the most recent slide is its pace, as well as the fact it’s happening while central banks are now lowering benchmark rates.
What’s driving the selloff?
Bond investors are apprehensive about lingering inflationary pressures in major economies. The long bond selloff gained pace in December, when Fed officials reined in the number of cuts they expect in 2025 after data raised concerns that inflation may be settling above the central bank’s 2% target. There’s also the likely impact of potential tax cuts and import tariffs being weighed by incoming US President Donald Trump that could add to inflationary pressures in a resilient economy. That has helped to push up measures of the term premium, a proxy for the compensation demanded from investors to own longer-term bonds.
Is bond supply a factor?
Certainly. Late last year, investment manager Pimco said it was “less inclined” to purchase Treasuries with extended maturities in light of ballooning US deficits.
One way of assessing the impact of supply on the increase in bond yields is through so-called swap spreads. That’s the difference between, say, a US Treasury yield and the comparable rate on a swap with the same maturity. If debt supply is weighing on the market, you would expect bonds to yield more than swaps in order to attract buyers. The 30-year US swap spread shows bonds yield over 80 basis points more than equivalent swaps, compared to about 70 basis points at the start of the year.
How far could long-bond yields rise?
There’s no hard ceiling on how high yields can go, though history shows the US government is likely to find buyers at higher rates. When 30-year yields broke above 5% in October 2023, the move quickly dissipated as investors sought to lock in those attractive levels. The 30-year rate finished 2023 around 4%.
Some bond investors don’t rule out a further spike in yields, with ING seeing the 10-year at 5%. T. Rowe Price has also called for a 10-year yield of 5% in the first quarter of 2025 — and even hinted at the prospect of an eventual rise to 6%.
Apollo’s chief economist, Torsten Slok, warned the rise in Treasury yields this week could be a “potential Liz Truss moment,” in an interview on Bloomberg Television.
In principle, central banks could intervene if the market moves pick up pace. The Fed in 2012 pursued Operation Twist, where it sold short-term Treasury securities and purchased long-term notes. More recently, the BOE started buying long-maturity gilts in 2022 to stave off a disorderly selloff. There is no indication that either are considering similar moves this time.
What does that mean for other assets?
The theory goes that the higher the compensation on offer from bonds, the more they should pull money out of other asset classes including money-market funds and equities. Indeed, bond funds attracted record inflows last year as investors looked to lock in higher yields.
Some Wall Street strategists are watching bond yields closely. Morgan Stanley’s equity team, led by Michael Wilson, said rates were “the most important variable to watch” in early 2025.
And how about the real economy?
Longer-term yields are particularly important in the US, where mortgages are typically fixed for 30-year terms. That means lenders set the interest rate with reference to where long-term rates are trading so they can hedge their exposure. Big companies, too, often like to borrow using long-maturity bonds which are priced relative to government debt. If market rates continue to head higher, this could potentially slow the economy by raising the cost of funding home purchases and running businesses.
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