Akash Jha
Next week, as investors submit bids in two high-risk auctions, the highest long-term Treasury yields in years will be on full display, just days before the Federal Reserve’s potentially game-changing annual gathering in Jackson Hole.
Year-to-date profits that once topped 4% have been completely wiped out by a persistent selloff in the Treasury market this month. Inflation-protected bonds with maturities of 20 and 30 years will be offered for sale by the US Treasury next week. If investors are wary, the return rate must rise to entice them back.
For the better part of the last two years, shorter-term Treasury tenors have led Treasury rates higher as investors have prepared for interest rate hikes from the Federal Reserve totaling over five percentage points. Long-term interest rates have taken the lead over the past month as concerns about the robustness of the labour market, persistently high inflation, and an increasing supply of new Treasuries sold to reduce the federal budget deficit have taken the stage.
According to George Catrambone, head of fixed income at DWS Americas, “no one wants to step in front of the issuance goods train,” particularly in the long term. “There aren’t great reasons to front-run a hawkish Fed, additional supply, and very resilient US economic data prints.”
Bondholders are feeling the pain keenly; a Bloomberg index of Treasuries maturing in 10 years or more has down 5.7% this August, putting it on track for its worst month since September.
Due to the smaller investor base for 20-year bonds and 30-year TIPS compared to other Treasury instruments, demand at the upcoming auctions will be closely monitored for any indication the present rout is nearing an end, or perhaps has additional room to run.
Certainly, the 20-year has its fans, in part because its yield has consistently been higher than that of the 10-year and 30-year Treasury benchmarks.
Whether or not pension funds and insurance firms purchase 30-year TIPS at a 2%-plus yield not seen since 2011 is a major factor in the sale. Although they have been noticeably absent from these auctions, several Wall Street pros are optimistic that they will soon return.
After the debt auctions have concluded, the final full week of August featured the Federal Reserve’s annual confab in Jackson Hole, which has occasionally been used to shift market expectations for monetary policy.
Chairman Jerome Powell’s hardline stance The bond market’s faith in 2019 rate decreases is set to be put to the test on Friday. Positioning polls reveal that many fund managers hold the view that it is better to be an owner in the 5- to 10-year sector of the market.
However, a struggle is brewing in the long run, where investors are demanding a risk-free rate of return that has increased due to a rise in so-called real yields that are not affected by inflation.
In light of data uncertainties that could lead to another Fed rate hike later this year and maintain policy well over 5% in 2024, investors are demanding a larger premium for holding long-dated debt. Meanwhile, the Federal Reserve is pulling back from the market in an effort to reduce its balance sheet, adding to supply worries as the Treasury increases sales to pay the fiscal deficit.
Deutsche Bank’s head of US rates strategy, Matthew Raskin, emailed clients, “The question of how much term premium needs to be priced is the big one.” As one Fed employee put it, “some of the term structure models used by Fed staff still have historically low longer-dated term premia, which seems… wrong.”
Bank of America’s director of US rate strategy Meghan Swiber is interested in whether or not the Fed’s current long-run policy rate estimate of 2.5% should be modified higher in light of the robust economy.
To paraphrase, “at Jackson Hole, there is really going to be two points of focus,” she remarked. We need to know two things: (a) “how much, if at all, they need to adjust the Fed funds rate higher,” and (b) “where do they think these longer run rates ultimately have to be,” as the tail end of the curve is having trouble keeping up.
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