The yield on the 1-year Treasury note is testing 4%, a level that traders say could spill over into other rates and send shivers down the financial markets as the Federal Reserve presses ahead with its campaign to lower its balance of 8.8 billion dollars. .
That balancing process, known as “quantitative tightening,” is meant to complement the central bank’s series of aggressive rate hikes, one of which is expected to arrive next Wednesday. The Fed is “now tightening in full steam” as the “training wheels” roll out of QT after a slow start, according to BofA Securities rates strategist Mark Cabana. And traders say that’s one of the reasons behind the one-year yield’s moves on Thursday, which included intermittently touching or rising slightly above 4% before pulling back again.
“Four percent is a magic number that scares a lot of asset markets, including equity markets, and basically everyone,” said principal trader John Farawell of Roosevelt & Cross, a bond underwriter in New York. The Fed’s QT process is one of the reasons this is happening and “it’s increasing pressure on the front of the curve.”
A 4% yield is likely to spill over into other rates in the Treasury bond market as expectations around aggressive rate moves by the Fed solidify, Farawell said by phone on Thursday. “You may see more of the same that you’re seeing now, more stress in the stock market, and equity people may get out.”
In fact, the three major US DJIA indices,
ended lower on Thursday as Treasury yields continued to rise.
Data provided by Tradeweb shows that the one-year rate TMUBMUSD01Y,
it was slightly above 4% three times during the New York morning and afternoon, before pulling out.
The one-year yield, which reflects expectations around the Fed’s short-term policy path, has not ended the New York trading session above 4% since Oct. 31, 2007, according to FactSet .
Meanwhile, the bond market showed more worrying signs about the outlook: the spread between 2-year and 10-year Treasury rates fell to minus 41.3 basis points, while the gap between 5-year and 30-year rates narrowed. at minus 19.3 basis points.
Financial market participants have slowly come to the view that the Federal Reserve will continue to tighten financial conditions until something breaks in the US economy, in order to reduce the strongest period of inflation in four decades.
Aside from QT, other reasons for the one-year yield’s move toward 4% is that traders are increasingly focused on the level at which policymakers will end rate hikes, known as the rate. terminal, and there is anxiety about the possibility that one of the Fed’s next moves could be a gargantuan 100 basis point hike, according to one strategist.
Higher rates, particularly on one-year Treasuries, benefit investors who haven’t yet had a chance to get into the fixed-income market, giving them the opportunity to earn higher yields at a lower price. “We could see investors going to the safety of Treasuries and we may see more players entering the bond market. Treasuries could become a viable option for some people,” Farawell of Roosevelt & Cross told MarketWatch. He noted that the 1-year Treasury rate has been “fractional,” or close to zero, between 2020 and the beginning of this year.
When policymakers flooded the markets with liquidity during the era of easy money, through the process known as quantitative easing, stocks were seen as one of the biggest beneficiaries. Therefore, it is logical that the opposite process, quantitative tightening, and its acceleration could further affect equities.
This month, the Fed’s maximum balance sheet shrink rate increased to $95 billion a month in Treasuries and mortgage-backed securities, up from $47.5 billion the previous month. That ever-increasing pace of QT will put more Treasuries and mortgage-backed securities in private hands, create aggressive competition among commercial banks for funding, and lead to higher borrowing costs, according to BofA’s Cabana.
QT’s impact to date “has been minimal,” Cabana wrote in a note Thursday. However, over time, this should ultimately result in “higher funding rates, tighter financing conditions and headwinds for risky assets.”
Still, there was a sense among traders that the Fed’s quickening pace of QT is already having an impact.
“There is a psychological impact of hitting 4% on the 1-year yield, which has the potential to spill over into other offshore capital markets,” said Larry Milstein, senior managing director of government debt trading at RW Pressprich & Co. . In New York. “People now realize that the Fed is going to have to stay higher for a long time, inflation isn’t coming down as fast as expected, and the terminal rate is going up.”
“For a long period of time, people have been talking about TINA, but it doesn’t necessarily have to be in the stock market to make a return,” Milstein said by phone. TINA is an acronym used by marketers for the idea that “no alternative” to actions.
Like Farawell, Milstein sees more investors taking money out of stocks and putting it into short-dated Treasuries.