Treasury yields continue to surge, defying expectations and causing further strain in the U.S. core bond market. On Tuesday, yields on the 2-year Treasury note reached 5.2%, marking its highest level in over 17 years.
The last time short-term Treasury security yields were this elevated was back in June 2006 when the federal funds rate was holding steady at around 5% to 5.25%.
This upward movement in yields followed the unexpectedly robust retail sales figures in September, published earlier today, which underscored the continued strength of consumer demand in the country. This, in turn, dispelled any concerns within the Federal Reserve about an economic slowdown.
Additionally, inflation has proven to be slightly stronger than anticipated in the past month, with the Consumer Price Index (CPI) showing an annual increase of 3.7%, surpassing the earlier forecast of 3.6%.
While market sentiment suggested the Federal Reserve is unlikely to raise interest rates further, with a 91% probability of rates remaining unchanged at the Nov. 1 FOMC meeting according to CME Group Inc.’s Fed Watch, the persistent resilience of the U.S. economy is fostering the possibility of a prolonged period of elevated interest rates.
In its September 2023 meeting, the Fed maintained the target range for the federal funds rate at a 22-year high of 5.25% to 5.5%, and the latest FOMC minutes indicate a majority of participants leaning toward another rate hike before the year’s end.
Chart: 2-Year Treasury Yields Surge Past 5.2%, Highest Since June 2006
US Treasuries Are Losing Their Strategic Footing, El-Erian Says
Renowned economist Mohamed El-Erian, president of Queens’ College, Cambridge, and chief economic adviser at Allianz, voiced his concerns on Tuesday, asserting the “world’s most critical benchmark market is embarking on an unpredictable journey with an uncertain destination.”
In an article published in the Financial Times, El-Erian highlighted the evolving nature of U.S. Treasuries, suggesting that they are losing their long-term strategic stability and may even relinquish their short-term stabilizing role.
While U.S. Treasury bonds have traditionally been considered a safe haven during times of economic turmoil, they have recently shown signs of abandoning this reputation.
The iShares 20+ Year Treasury Bond ETF TLT, for instance, has shed over half of its value since March 2020 highs.
Even short-term Treasuries, as tracked by the IShares 1-3 Year Treasury Bond ETF SHY, and often considered as the ultimate risk-free asset, are down 7% from their 2020 peak, a substantial decline for a cash-like proxy.
El-Erian pointed to several sources of uncertainty, including questions surrounding the appropriate level of interest rates, the delayed impacts of a concentrated series of rate hikes, the effects of a shrinking balance sheet and the absence of an effective monetary policy framework within the Federal Reserve.
According to El-Erian, there is currently a shortage of buyers in the Treasury market, as foreign investors exhibit hesitation, partly due to geopolitical factors. A substantial portion of the domestic institutional investor base, including pension funds and insurance companies, already holds significant quantities of bonds, which are experiencing substantial mark-to-market losses.
El-Erian cautioned there may be times when technical factors take precedence over fundamental considerations, resulting in price volatility that could potentially destabilize both financial markets and the broader economy.
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