Reasons Behind the Spike in 10-Year Treasury Yield

US 10-year treasury bond yield spiked to a new level of 1.614% in late-Feb 2021. It was just a year ago (in early Feb 2020) when it touched its multi-year low level of 0.533%. It is almost a 100-bps spike in yield in a matter of just one year.  It appears quite likely that it will cross 2% level in next few months.

This is how to interpret, this Bond yield spike

A spike in bond yield bodes well if the economy is not too much heated (inflation within comfortable zone). A spike in bond yields is a reflection of expectation for a good economic growth. US real GDP is expected to grow by 4.5% in 2021 (after a forgettable year in 2020 when it dropped by -3.5%). It is almost a v-shaped recovery and the same is reflecting in US 10-year treasury yield.

A spike in 10-year treasury bond yield is a warning signs that FED may be prompted to increase the overnight Federal fund rate. This will in turn impact the interest rate expense of leveraged firms and retail customers (especially those who chose to go for floating rate).

Once FED raises the Federal funds overnight rate, then this will lead to increased demand of USD and funds inflow into the USD. This will, in turn, lead to USD appreciation against other currencies. Other country’s interest rates must rise to prevent a sudden domestic currency’s depreciation caused by the loss of funds (Capital outflow).

Impact on Singapore economy

Singapore economy will not remain decoupled with this event. It’s benchmark interest rate SIBOR and SOR will have to move up to mitigate (loss of funds) the capital outflow.

SIBOR and SOR have already started to move up anticipating a possible Federal Reserve rate hike moves.

Exchange rate plays a bigger role in export driven economy such as Singapore (depreciation of currency is positive for exports). So, if there is an expectation of interest rate hike then the exchange rate is expected to appreciate as well. This will adversely affect the exports.

Possible justifications for this spike in bond yield

Supply related factors –

  • Monetary policy – Interest rates are a significant part of a nation’s monetary policy. Monetary policy is shaped by a government administration, and executed through its central bank. Central Banks are aware of their ability to influence the asset prices through their monetary policy. They often exercise this special power to manage the ups and downs in the economy. During recessions, they take the necessary actions to hold off the deflationary forces by lowering interest rates, leading to increases in asset prices. The similar action was undertaken by FED to handle the demand shocks caused by COVID19 pandemic in 2020.

Increasing asset prices has a stimulating effect on the economy. When bond yields spike, it results in higher borrowing costs for corporations and the government, leading to reduced spending. Mortgage rates may also go up with the demand for housing likely to decrease as well.

  • Fiscal Policy – Higher deficit requires incremental borrowing to fund the additional level of deficit, and more borrowing means higher interest rates. All these fiscal excesses do not get an easy pass from all the quarters. Mr. market (hedge funds, pension funds, investors, etc.), reacts through the treasury bond yields. They sell off the bonds market. Though, these are just market’s opinion, they can still be wrong, but nonetheless, it reflects the collective wisdom of the funds and capital markets.

Demand related factors –

  • Inflation – Inflation rate in US as published by BLS is provided in below table. Inflation rate has continuously increased ever since it witnessed its all-time low level of 0.1% in May 2020. Average inflation rate in 2020 stands as 1.2%. In Jan 2021, it went up to 1.4%. Inflation rate does impact 10-Year treasury bond yield a big way.

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Published by Amit

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