Treasuries rallied taking 10 year yields above 5.0% on Monday, hitting a 16 year high, continuing the recent sharp swings.
The yield peaked at 5.03%, the highest since 2007 before quickly falling to 4.83%.
At the start of the year, the 10-year yield was 3.90%. Contrary to market expectations of a decline and a banner year for bonds in 2023, the yields have consistently risen. The rising yields is primarily attributed to investor sentiment finally aligning with the belief that the Fed will maintain elevated rates until the 2% inflation target is met. The Federal Reserve have been signaling this for months.
Given this many investors are hesitant to hold onto longer term bonds that only pay, say 2% yield, leading to the widespread selling of bonds.
The fiscal spending deficit is another contributing factor, as governments must find ways to fund their spending. With increasing borrowing and higher interest rates, governments incur greater interest costs. To address this, the US treasury releases more bonds and notes, saturating the market.
Another driving force behind treasury yields is the Feds quantitative tightening policy. The Fed has a few tools it uses to maintain the US economy, by keeping inflation in check and maximizing employment. One is the use of interest rates whilst the other is quantitative tightening. Whilst the Fed is increasing interest rates they’re also offloading bonds acquired mainly during the pandemic, this shrinking of the balance sheet is known as quantitative tightening.
The balance sheet reduction will help to cool off the economy, whilst the higher interest rates will do most of the work.
The Fed’s balance sheet is currently at around $7.9 trillion, down from its peak of $9 trillion in early 2022.