The fall in US bond yields in recent weeks is a sharp reversal from a dramatic rise that started in the dying embers of 2020.
After entering January below 1%, the benchmark 10-year yield rose above 1.78% in late March before retrenching near the 1.6% level for much of April and then continuing to edge lower through June into the early days of this month when they slid sharply from July 1 onwards.
Shorter-term bond yields have not fallen at the same pace as long-term rates, causing a so-called flattening of the Treasury yield curve.
That’s a concern for some investors because it is a sign markets see economic growth slowing (slower growth usually means lower rates or smaller rises in the next year).
That is at odds with what is happening in most major economies where economic activity, employment had household spending remains solid to boom-like.
But the new round of Delta variant Covid infections is starting to worry markets more and more.
Australia is not immune, nor are countries near us like Indonesia, Fiji and PNG. India, Japan, Spain, the UK, South Africa are all reporting rising cases of Delta Covid infections.
Strategists say the fall in yields has already triggered a new rotation of investors out of value back into the techs – the so-called reflation trade that started in November, 2020.
Hence Apple’s record close on Wednesday with its market value topping $US2.4 trillion and the long boom in shares in bank stocks and other financials, especially the Big Four Australian banks which are up by 40% or more this year.
Thursday’s low of just under 1.25% for the 10 Year US Treasury bond was the lowest since February.
Australian bond yields have been following the US 10-year yield lower with the yield on our 10-year bonds reaching 1.31% on Thursday. That yield is also the lowest since February of this year.
Economic growth in Australia is certainly better than then and the rebound in jobs much greater than forecast, so the 10-year bond yield should be higher than 1.31% or 1.50%.
(The bond buying quantitative easing by the Reserve Bank is keeping our 10-year bond yield close to that of the US to put a lid on the value of the Aussie dollar as well).
Economists at Moody’s said in their weekly note on Friday that “Technical factors are pulling the U.S. 10-year Treasury yield lower recently.”
“They include the dearth of Treasury issuance and short coverings. More fundamental factors pushing rates lower are the fading reflation trade and peak U.S. growth. On the technical factors, the Treasury has drawn down its General Account at the Federal Reserve faster than expected.
“The Treasury’s General Account at the Fed has fallen by more than $1 trillion since mid-September. This has reduced the need for the Treasury to issue additional Treasury notes and bonds to finance past rounds of fiscal support.
“Less Treasury supply, all else being equal, pushes Treasury prices higher and yields lower. Its account remains double that seen pre-pandemic, so it still has some cash it can tap into. This week there is also little Treasury issuance, and what is scheduled to be issued is mostly bills.
“This dearth of bill supply is also putting downward pressure on rates this week. There also appears to be another wave of short coverings as traders are ditch losing positions.
“The bond market also likely got ahead of itself on the reflation trade, since a hot U.S. economy doesn’t mean runaway inflation is guaranteed. Also, long-term rates are down across many parts of the globe.
“This may signal renewed angst that the pandemic will re-intensify again as the Delta-variant gains traction and vaccinations in much of the world are going slowly.
“The Delta variant of COVID-19 is now thought to be the dominant strain of the virus in the U.S. More-rural areas have sparser vaccine coverage and have seen a steeper rise in COVID-19 cases,” Moody’s economists wrote.
Still the fall in the value of the Australian dollar, and the 10-year bond yield in the US and in Australia, has taken the pressure off the need for the RBA to try and keep the currency lower than it would have been.
The fall in yields and in the value of the Aussie validates the RBA’s decision this week to cut its bond buying Quantitative Easing (which is focused on the 10-year maturity) by 20% to $4 billion a week.
With another review set for November, don’t be surprised if that is cut further to $3 billion a week or even $2.5 billion is the Aussie remains weak and the US 10-year yield also stays weak, though if the technical factors discussed by Moody’s change (because they appear temporary), then rates could rebound and the Aussie dollar edge higher.
Moody’s though remains confident that the slack in the US labour market will be soaked up by 2023.
Unlike Australia where total employment is now above pre-Covid levels, the US labour market is still 6.8 million jobs short (let alone rising above the February, 2020 level as Australia has).
“Nevertheless, the economy is on track to regain the remaining 6.8 million jobs lost during last spring’s recession by next summer and return to full employment no later than early 2023, Moody’s said on Friday.
“This forecast may look a bit optimistic as the unemployment rate edged higher in June to 5.9%. Full employment would be consistent with an unemployment rate that is well below 4%. But unemployment is expected to decline quickly in coming months at the same time labor force participation is likely to increase significantly.
“Pushing up unemployment is the surge of workers quitting their jobs, emboldened by the record- shattering number of open positions and better wages employers are offering to entice new job applicants.
“Many of the unemployed are simply transitioning from one job to the next. Also adding to the unemployed is an increase in the number of re-entrants to the workforce who rightly feel this is the time to find a good job.
“The economic recovery is on track to be among the strongest and quickest in history. We expect some 10 million jobs to be added this year and next, and it would take a lot to meaningfully dent this growth, let alone derail it.
“The recovery must overcome several challenges, including working through a mélange of supply-side disruptions, navigating the foreclosure cliff, and avoiding another eruption of the pandemic,“ Moody’s added.
Now this is not the stuff of bond yields at 1.30%, or 1.50%. It is more like yields edging higher back to the March peak of 1.788% because the strength of the US economy is being sustained, inflation has eased a touch and looking to reflect the faster pace of growth and not the one offs from the post-Covid rebound, such as the shortage of computer chips and chipping delays.
