As the global bond market sell-off intensified sharply over the past few sessions and pushed yields in some major developed economies to at least their highest levels in nearly a decade, it seemed as if this week the bond market finally understood what central bankers have been warning all year: High interest rates are here to stay.
On Wednesday, Beijing time (October 4), the 10-year US bond yield, which is known as the "anchor of global asset pricing", approached 4.9%, and the 30-year US bond yield broke 5%, both of which hit a new high since 2007. In Europe, the region's benchmark 10-year German Bund yield climbed to 3 per cent, its highest since 2011, while the UK 30-year bond yield rose to 5.115 per cent in early trading, its highest since September 1998. In Asia, Japanese and South Korean 10-year government bond yields climbed to 1.545% and 4.3%, respectively, the highest since January 2014 and 2011.
The last time yields were this high was during the 2007-2008 global financial crisis.
What, then, was the cause of the surge in Treasury yields? How do these factors compare with the current surge in Treasury yields? What was the impact on the market after the rise in US bond yields 16 years ago?
Sixteen years ago, there were three "triggers" : the housing crash, interest rate rises, and oil prices
Treasury yields are the rates at which the U.S. government can borrow money for different maturities, which are determined by the supply and demand for bonds in the market. When U.S. bond yields rise, it means that demand for U.S. debt is low, and the U.S. government must pay higher interest rates to attract investors, which also passes through to consumers and businesses.
Treasury prices and yields move in opposite directions: the higher the price, the lower the yield, and vice versa. Global bond prices have fallen 3.5 per cent so far this year, according to Bloomberg data, while ICE's US bank bond Volatility Index on Tuesday jumped to its highest level since May. The average price of a bond in the Bloomberg Treasury Index has fallen to 85.5 cents, just half a cent above its record low in 1981.
After officials from major central banks, including the Federal Reserve and the European Central Bank, made it clear recently that they are unlikely to ease policy anytime soon, investors holding long-term government bonds are demanding higher compensation.
In the United States, the ballooning federal budget deficit has led to increased issuance of Treasury bonds, weighing on long-term Treasuries. In fact, there are many other factors affecting the decline in long-term Treasury prices.
In 2007, according to foreign media reports, there were three main reasons for the decline in US bond prices/soaring US bond yields: First, the "avalanche" of investor and consumer confidence due to the subprime crisis and the collapse of the housing market has increased investor demand for safe haven assets while lowering their expectations of future inflation and economic growth, making US Treasuries less attractive.
Secondly, in order to curb inflation, the Federal Reserve raised the federal funds rate from 1% to 5.25% from July 2004 to August 2006, which made short-term US bonds more attractive than long-term US bonds, and increased the expectation that the Federal Reserve would continue to raise interest rates in the future, and long-term US bonds naturally became less investment value.
Finally, global oil prices rose due to geopolitical tensions and supply problems: on September 12, 2007, the international crude oil price exceeded $80 / barrel for the first time, and then accelerated, and on October 18, 2007, the international crude oil price exceeded $90 / barrel for the first time. The rise in crude oil prices increases production and transportation costs for many businesses and consumers, as well as adding to inflationary pressures and reducing the real return on U.S. debt.
In this macro environment, the 10-year US bond yield reached 5.32% in 2007, the 30-year US bond yield hit 5.33% in July of the same year, and the two-year US bond yield reached 5.1% in November of the same year, which was higher than the Federal Reserve's target interest rate at the time...
Back to the present, the picture seems somewhat similar: on Tuesday, October 3, the average 30-year mortgage rate hit 7.72%, the highest since 2000. This year, international oil prices remain high and volatile, WTI crude oil futures prices have risen by 18% since the beginning of the year, and the cumulative increase since the beginning of July has been more than 30%.
In addition, since the Federal Reserve opened this round of the most aggressive interest rate hike cycle in the post-Volcker era in March 2022, the effective federal funds rate of the United States has soared to a range of 5.25% to 5.50%, a new high since 2006. Since the recent Federal Reserve FOMC policy statement and public hawkish signals from officials, Treasury maturities have continued to climb.
Morgan Strategist: The current situation is similar to that before 2008
The International Monetary Fund (IMF) said in its blog post that "US Treasuries are the pricing basis for fixed markets and affect virtually any security in the world." Given this, a sustained and rapid rise in yields could trigger a repricing of risk, resulting in a general tightening of financing conditions and destabilizing emerging markets, disrupting the ongoing economic recovery."
In addition to the effects of higher borrowing costs mentioned above, a surge in Treasury yields widens the spread over interest rates on other securities, such as corporate bonds, mortgages and credit cards, increasing the risk premium and risk of default in the latter, making it harder for investors to sell and refinance, leading to a credit crunch and liquidity crisis. The surge in US bond yields was one of the main factors in the 2007-2008 global financial crisis.
"The multi-year highs in U.S. yields are starting to have an impact on other areas and sectors of the global fixed income space," HSBC strategist Steven Major wrote in a note to clients Wednesday, referring to the current spike in U.S. yields.
And it's not just HSBC. Many on Wall Street are getting nervous - jpmorgan strategist Marko Kolanovic wrote in a note that it's "similar to pre-2008."
In his report, Kolanovic divides the global US economy after the end of the 2007 Fed rate hike cycle into three phases that are eeringly similar to, and in some cases even consistent with, the current situation.
Phase 1: The Fed completed its last rate hike of the then tightening cycle on June 30, 2006, when the federal funds rate was raised to 5.25% (in line with the current level). At the FOMC's August 2006 meeting, risk assets began to rally strongly, and the "bull market" continued into early 2007. However, as the Fed raised interest rates by 425 basis points during the tightening cycle at that time, borrowing costs rose sharply and US GDP fell sharply.
In the first phase, the consensus was that the US economy would slow rapidly, the housing market would fall sharply, and Fed policy would shift to cutting interest rates in time to save the economy.
Phase Two: A series of strong economic data in late 2006 and early 2007 convinced the market that the U.S. economy was shaking off the effects of high interest rates and high commodity prices. The strong economic data has dashed the expectations of the optimistic doves for the Federal Reserve to cut interest rates, and the market has gradually accepted the view that the Fed has achieved a soft landing. At that time, US inflation was still showing stickiness, and although the Federal Reserve suspended interest rate hikes in August 2006, there was still no clear sign of a change in the dove, but one after another publicly made some hawkish remarks.
For this phase, Kolanovic makes it clear: This is the situation we are in now.
The third stage: June to October 2007, as inflationary pressures persisted, investors began to realize that the Fed was not only unlikely to cut interest rates, but could continue to raise interest rates to contain stubborn inflation. Under such a sharp contrast of expectations, the market risk bias has improved rapidly, and risk assets have begun to be sold on a large scale. Between October 2007 and March 2009, the S&P 500 fell 57 per cent in just six months, its worst six-month decline in 70 years.