How Much Longer Will U.S. Treasury Bonds Decline?

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In recent times, the soaring yields on U.STreasury bonds have cast a significant shadow over the global financial landscape, instigating a wave of pressure felt across various markets worldwide.

On October 23rd, the yield on the 10-year U.S

Treasury bond, often termed as the “anchor for global asset pricing,” breached the 5% mark for the first time since 2007.

An increase in bond yields invariably signifies a decline in prices, indicating that the current U.STreasury bond market is grappling with intense selling pressure.

As U.S

Treasury prices fell, global financial markets quaked, pushing the S&P 500 index to a five-day losing streak and marking its lowest point since May.

On October 24th, Asian markets experienced widespread turbulence, with major indices such as Hong Kong's Hang Seng Index, along with those in South Korea and Japan, facing declines during intraday trading.

Since mid-July, U.S

Treasury yield increases have accelerated.

Statements from Federal Reserve officials, coupled with recently strong economic data from the U.S., suggest that interest rates could remain higher for longer than many had anticipated.

In interviews, Eric Huang, Managing Director and Head of Fixed Income for Asia Pacific at Invesco, outlined five key reasons contributing to the rise in U.S

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Treasury yields.

Firstly, the U.Seconomic growth rate in the first half of this year was significantly higher than expected. This has led to an upward adjustment in market expectations regarding the economy and a downward adjustment in anticipated unemployment rates, necessitating a repricing of the Federal Reserve’s interest rate trajectory.

Secondly, while inflation in the U.S

has moderated this year, it remains above the Federal Reserve’s target, with core inflation levels still relatively high. Recent oil price hikes have also added upward pressure to overall inflation.

Data released by the U.SDepartment of Labor shows that the Consumer Price Index (CPI) in September rose by 3.7% year-on-year and by 0.4% month-on-month, both exceeding expectations.

Thirdly, the Federal Reserve has indicated a hawkish stance. This confidence in the economic outlook has shaped perceptions about the pace of interest rate hikes, as many anticipated deflation at the start of the year, which has not materialized.

Last week, Federal Reserve Chair Jerome Powell delivered critical remarks before the New York Economic Club ahead of the November policy meeting, suggesting an inclination to maintain current rates while leaving the door open for future hikes should signs of robust economic growth emerge.

Powell stated that U.S

inflation remains excessive, and the journey to temper it could be rocky and prolonged, emphasizing the Fed’s dedication to sustainably reducing inflation to 2%. Achieving this might necessitate a stretch of subdued economic growth alongside softened labor market conditions.

Additionally, last Friday, Cleveland Fed President Loretta Mester indicated her belief that another rate hike may be on the table before the year's end, aligning with the Fed's September dot plot.

Fourthly, from a supply-demand perspective, the market is struggling to absorb a significant amount of U.S

Treasury supply, necessitating elevated yields to enhance attractiveness.

On the supply side, the U.Sgovernment is expected to continue running large deficits, implying an ongoing issuance of substantial bond volumesThe Treasury Department plans to net issue $1.01 trillion and $852 billion in bonds during the third and fourth quarters, respectively, while simultaneously the Fed continues a policy of quantitative tightening, having reduced its Treasury holdings by $1.3 trillion since 2022, thereby flooding the market with bond supply.

On the demand side, overseas investors have largely reduced their holdings, with total U.S

Treasury bond holdings down by $121 billion since 2022.

By the end of August, mainland China, as the second-largest overseas "debtor" of the U.S., saw its Treasury holdings shrink to $805.4 billion, the lowest level in 14 yearsJapan, the largest "debtor," also significantly cut its Treasury holdings by $30.4 billion in May, marking the largest monthly decline since October of the previous year.

Fifthly, there was a downgrade in the U.S

international credit rating. On August 1st, Fitch downgraded the U.Slong-term foreign-currency issuer default rating from "AAA" to "AA+." "Many funds that were previously eligible for AA ratings may now be sold or reduced," analysts noted.

The implications of rising U.STreasury yields are extensive, as the Treasury market is viewed as the cornerstone of the global financial system.

Higher Treasury yields and premiums are expected to tighten financial conditions, suppressing investors' appetite for stocks and other risk assets, while simultaneously raising the cost of credit for both businesses and individuals.

According to data from S&P Global Market Intelligence, global stock markets have recently reached their lowest levels since April. The S&P 500 index has declined about 7% from its peak earlier this year, as the allure of U.S

government bond yields attracts investors away from the stock marketSimultaneously, mortgage rates have risen to their highest levels in over twenty years, placing significant pressure on the U.Sreal estate market.

In the realm of corporate bonds, the recent surge in Treasury yields has caused credit spreads to widen once again, increasing financing costs for potential borrowers, with particularly notable pressure on junk bondsAn index tracking global high-yield bonds recently saw its average yield rise to 9.26%, the highest level since last November and nearly double that of early 2022.

However, the surge in Treasury yields has simultaneously accelerated demand for the U.S

dollarSince mid-July, when yields began their rapid ascent, the dollar has appreciated by approximately 7% against a basket of G10 currencies. The dollar index measuring the strength of the dollar against six major currencies recently approached a ten-month high.

Currently, major financial institutions such as Bank of America, Morgan Stanley, and Goldman Sachs indicate that Treasury yields have peaked.

Morgan Stanley stated that once the 10-year Treasury yield reaches 5%, it will be an "excellent entry point."

Goldman Sachs projected that the 10-year Treasury yield could drop to about 4.2%-4.3% in the short term.

Michael Hartnett, Chief Investment Strategist at Bank of America, believes that U.S

Treasuries will emerge as the best-performing assets in the first half of 2024.

In addition to major investment banks, several noted stock bearish proponents in the market are beginning to "retreat" as well.

On October 23rd, hedge fund maestro Bill Ackman, founder of Pershing Square Capital Management, announced he had closed out his short positions on long-term Treasuries.

Ackman conveyed that, given the multitude of global risks, continuing to short the debt market at current rate levels no longer seems prudent, additionally remarking that the speed of the U.S

economic slowdown is faster than recent data suggests.

Following Ackman's latest statements, the 10-year Treasury yield saw a marked decrease, plummeting over 10 basis points from its daily peak to around 4.88%.

Legendary bond investor Bill Gross also expressed his views on October 23rd, indicating he is buying short-term rate futures tied to the Secured Overnight Financing Rate (SOFR). He anticipates that the spread between two-year and ten-year Treasury yields, as well as between two-year and five-year yields, will turn positive by year-end.

Gross's actions reflect his expectation of an economic downturn in the U.S