The U.S. Treasury market, the world’s largest and most liquid bond market, is undergoing a dramatic selloff that has sent yields to their highest levels in more than a decade. The surge in yields has sparked turbulence across various asset classes, from stocks to real estate, as investors adjust their portfolios to the changing interest rate environment.
What is driving the rise in Treasury yields?
Treasury yields, which measure the annual return investors get for lending money to the U.S. government, move inversely to bond prices. When bond prices fall, yields rise, and vice versa. The main factors behind the recent drop in bond prices are:
- The Federal Reserve’s hawkish stance. The U.S. central bank has raised its benchmark interest rate by more than 5 percentage points since 2021 to combat soaring inflation, which erodes the value of fixed-income payments. The Fed has also signaled that it will start tapering its massive bond-buying program, which has supported the bond market during the pandemic, by the end of this year.
- The fiscal outlook. The U.S. government is running a record-high budget deficit, partly due to the massive stimulus spending to support the economy during the COVID-19 crisis. The Treasury Department has ramped up its borrowing to finance the gap, increasing the supply of bonds in the market. At the same time, the demand for bonds from foreign investors has waned, as they face higher hedging costs due to the stronger dollar and lower interest rate differentials with other countries.
- The economic recovery. The U.S. economy has rebounded strongly from the pandemic-induced recession, thanks to the rapid vaccination rollout and reopening of businesses. The growth outlook has improved, boosting expectations for higher inflation and interest rates in the future. This reduces the appeal of bonds, especially longer-dated ones that are more sensitive to inflation and rate changes.
How are Treasury yields affecting other markets?
The Treasury market is considered the bedrock of the global financial system, as it influences the cost of borrowing and lending for governments, corporations, and individuals around the world. Therefore, soaring Treasury yields have had wide-ranging effects on other markets. Some of them are:
- Stocks. Higher Treasury yields can curb investors’ appetite for stocks and other risky assets by tightening financial conditions and raising the opportunity cost of holding equities. High-dividend paying stocks in sectors such as utilities and real estate have been among the worst hit, as investors gravitate toward government debt. Shares of tech and growth companies, whose future profits are discounted more sharply against higher yields, have also suffered. The S&P 500 is down about 8% from its highs of the year.
- Dollar. Another upshot of the surge in yields has been a rebound in the dollar, which has advanced an average of about 7% against its G10 peers since the rise in Treasury yields accelerated in mid-July. The dollar index, which measures the buck’s strength against six major currencies, stands near 10-month highs. A stronger dollar helps tighten financial conditions and can hurt the balance sheets of U.S. exporters and multinationals. Globally, it complicates the efforts of central banks to tamp down inflation by pushing down other currencies. Traders have been on watch for weeks for a possible intervention by Japanese officials to combat a sustained depreciation in the yen, which is down 12% against the dollar this year.
- Real estate. The interest rate on the 30-year fixed-rate mortgage – the most popular U.S. home loan – has shot to the highest since 2000. That’s hurt homebuilder confidence and pressured mortgage applications. In an otherwise resilient economy featuring a strong job market and robust consumer spending, the housing market has stood out as the sector most afflicted by the Fed’s aggressive actions to cool demand and undercut inflation.