A Treasury Yield Surge and a Tantrum Without the Tapering

The start of 2021 has proved to be a challenging period for US government securities. An accommodative monetary policy and fiscal largesse, coupled with progress on the vaccination front, have not only improved the growth outlook, but have catapulted inflation expectations to highs not seen since 2008. This has created skepticism in investors’ minds that inflation, which was considered ‘dead’ for years, may be returning from ‘hibernation,’ and the Federal Reserve (the Fed) may be forced to tighten its policy sooner than expected. The yield on the 10-year US Treasury Note, which was hovering around 1% at the beginning of the year, is currently (as of March 5th) yielding around 1.55%. This is higher than the S&P 500 Index’s dividend yield, which according to FactSet is around 1.43%. 

This increase in yield, which was gradual during the initial few weeks, gained velocity on Thursday, February 25, when it hit a pandemic high of around 1.6%. As expected, the longer-duration segment generated the sharpest sell-off. This was mainly due to the lukewarm response to the seven-year Treasury note auction on Thursday, where primary dealers ended up as the significant buyers. This had a cascading effect on secondary market liquidity and Treasury futures markets. The ICE BofA MOVE Index, which measures bond market volatility, jumped to its highest level since April 2020. For bond market participants, it was a stark reminder of a similar market rout that prompted Fed intervention in March 2020. For the majority of risk-assets, it was a reminder of the 2013 ‘taper tantrum,’ but this time without the Fed tapering. 

Rising yields and the associated rise in borrowing costs put pressure on stocks trading at stretched valuations. Hence investors were seen rotating from ‘higher-duration’ names to ‘cyclicals’ and from ‘growth’ to ‘value’ in anticipation of business reopenings and optimism for a positive vaccine rollout. The bond sell-off adversely affected emerging markets assets too, as inflation worries and possible early tightening of monetary policy dampened the appetite for risk assets. Earlier in the year, a Bank of America survey indicated that a majority of fund managers considered emerging markets an attractive asset class for 2021. 

Federal Reserve Chair Jerome Powell repeatedly has communicated the Fed’s intention of keeping monetary policy accommodative, and hence the existing conditions are not exactly comparable to the 2013 taper tantrum. Moreover, in spite of the risk-free 10-year yield edging past the S&P 500 Index’s dividend yield, stocks still continue to offer a premium over bonds when factoring in the earnings yield. But as economic growth starts to pick up and pent-up demand pushes stock prices higher, elevated yields may continue to cast an impact on asset prices. As the market continues to digest incoming economic data, continued mismatches between the Fed and the market’s perception about inflation and yields might persist, and investors must be mindful of high-velocity yield surges and their cascading impact on market volatility. We believe that the recent bouts in market volatility make the case for ‘diversification’ even stronger. A well-diversified portfolio and a strong awareness about the underlying factor/sector/asset class risks might help in negotiating the market’s tantrums, with or without the tapering. 

Sources: (US Treasury bond wobble heightens concerns over health of $21tn market, Financial Times)

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