The biggest selloff in the long-end of the Treasury market since the day after Donald Trump’s presidential election victory in November 2016 saw analysts offer multiple reasons why panicked investors were dumping their holdings of U.S. government paper on Wednesday.
The 10-year Treasury note yield(BX:TMUBMUSD10Y) jumped 10.3 basis points to 3.161%, its highest since July 2011, marking its largest one-day yield rise since March 1. The 30-year bond yield advanced 11.3 basis points to 3.320%, its loftiest since September 2014, staging its largest daily climb since Nov. 9, 2016.
Rising yields appeared to dampen a rally for stocks, which finished well off of session highs. The Dow Jones Industrial Average (DJIA) still notched a record close, while the S&P 500 (SPX) clung to a 0.1% gain.
Bond prices move in the opposite direction of yields.
Here are some of the most popular explanations for the carnage:
Most investors pointed the finger at improving economic prospects after the Institute of Supply Management’s services gauge logged its second highest reading in its history, potentially raising expectations for gross domestic product growth in the third and fourth quarters. After all, the brunt of the selloff followed the data release at 10 a.m. Eastern.
“Overall, a very positive report across a wide spectrum of factors, consistent with the recent characterization of the economy as ‘extraordinary’,” said Jon Hill, fixed-income strategist for BMO Capital Markets, referencing Federal Reserve Chairman Jerome Powell’s recent remarks describing the current state of the economy.
Positive economic developments have also reinforced expectations the Federal Reserve will stick to program of steady, gradual rate increases. Stronger data now are unlikely to shift the Fed’s thinking on the number of rate increases next year, but analysts say the sharp rise in the inflation-adjusted yield could mean investors are demanding more compensation for holding long-dated debt amid growing uncertainty over the central bank’s decision-making as its benchmark lending rate approaches the neutral rate, the level of monetary policy that neither stimulates nor slows down the economy. The 10-year real, or inflation-adjusted, yield jumped 6 basis points to 0.986% on Wednesday.
“The real return number, which theoretically indicates that there is more uncertainly on the outlook where rates are going…You would theoretically need a steeper curve to compensate for that,” said Marvin Loh, senior fixed income strategist at BNY Mellon. A steeper yield curve refers to a wider gap between short- and long-dated yields.
Fading pension funds
But others were skeptical the selloff had much to dow with more evidence of economic strength. If the selloff was driven by solid data and stronger expectations for a more aggressive pace of rate hikes next year, they argued, the worst losses would have been incurred by the short-end of the bond market, which is more sensitive to shifts in the monetary policy outlook.
If you are betting on growth and inflation in the US…you sell the 5yr…expecting the Fed to keep on hiking. Selling the 30yr is a play on insurance and pension funds…and maybe the long term devaluation of the USD.
— govttrader (@govttrader) October 3, 2018
The skeptics highlighted an alternative explanation – the long-end of the bond market has lost its backstop as price-insensitive buyers like pension funds and insurance companies step away, despite the higher yields on offer. Such institutional investors often scoop up longer-dated bonds to match their equally lengthy liabilities.
Corporate pension funds were in a rush to buy the 30-year bond to take advantage of a provision allowing businesses to deduct contributions to their employee pension plans from their earnings, which came to an end in mid-September. As much of their buying was front-loaded, their purchases of long-dated Treasury’s have thinned down to a trickle, according to analyst at Deutsche Bank.
Yet others cited heavy bearish positioning combined with short-term traders waiting on the sidelines who were ready to add to the selling pressure once the 10-year note and the 30-year bond yields breached key chart levels. Technical analysts had said a rise in the 10-year yield beyond the 3.11% to 3.12% area, its previous seven-year high, would likely spark further selling.
“Losing technical support around 3.11% in the blink of an eye welcomed more volume from accounts that had set their automated programs to pounce on weakness,” said Jim Vogel, interest-rate strategist at FTN Financial.
Speculators and hedge funds held a record number of short positions, bets on prices to fall, on 10-year note futures as of Sept. 28, data from the Commodity Futures Trading Commission shows.