Treasury Market 2023 Gains Vanish as Long-Dated Yields Rise

Once again during the hoped-for year of the bond, investors in Treasury debt are looking at losses as long-maturity yields approach their 2022 highs.

(Bloomberg) — Once again during the hoped-for year of the bond, investors in Treasury debt are looking at losses as long-maturity yields approach their 2022 highs.

The year-to-date return from US government notes and bonds as measured by the Bloomberg Treasury index was -0.13% through Tuesday. The loss was poised to deepen Wednesday as 10-year and 30-year yields reached the highest levels this year after the minutes of the Federal Reserve’s last meeting flagged the risk of additional rate increases.

The US economy’s surprising resilience in the face of Fed rate increases totaling more than 5 percentage points over the past 18 months, combined with expectations for increased quantities of Treasury debt over the coming quarter to plug bigger federal deficits has prompted investors to demand higher interest rates. That erodes the value of notes and bonds sold at lower rates earlier in the year.

“Policy is biased to keep a tighter stance for longer,” said Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investments. Additionally, “we probably have room to take out some easing priced in.”

In the market for inflation-protected Treasury debt, the 10-year real yield exceeded 1.9%, a new high since 2009. Insulated from the effects of inflation, real yields represent the risk-free rate of return investors demand.  

Upward pressure on real and nominal yields from strong economic growth is being exacerbated by growth in the supply of Treasuries as the Fed sheds some of its holdings, necessitating larger auctions to the public.

In the minutes released Wednesday, some Fed officials were noted to have said that the process could continue alongside eventual rate cuts. 

Increased borrowing in the form of bigger Treasury auctions “will be captured via term premium, especially real rates, as the cost of funding rises to take down all this debt,” said George Goncalves, head of US macro strategy at MUFG.

The Fed last month raised the policy rate to 5.25%-5.5%. Swaps referencing future Fed meeting dates continue to anticipate rate cuts in 2024, however the amount of easing priced in has been reduced to about a percentage point. With regard to Treasuries, the Fed via it’s QT is allowing up to $60 billion a month roll off its balance sheet. 

Read more: US Ramps Up Debt Issuance, Adding Fuel to Selloff in Treasuries

Ten- and 30-year Treasury yields rose to the highest levels since October Tuesday after stronger-than-anticipated July retail sales data challenged expectations for Fed rate cuts beginning next near. 

The two-year note’s yield, which is more sensitive to changes in the Fed’s policy rate, is around 4.98%. It topped 5% Tuesday for the first time since July, when it peaked near 5.12%.

The Treasury index year-to-date return was negative — signifying that bond interest payments are more than offset by the price declines associated with rising yields —  from late February to early March as yields climbed in anticipation of a possible re-acceleration in the pace of Fed rate increases. Gains subsequently accumulated — topping 4% year-to-date in early April — as the first US bank failures since 2008 sparked a shift in the outlook.

“Treasury auction sizes will go up again — over the next couple of refundings in November and February — and if inflation doesn’t come back down, the market will need higher yields to absorb that supply,” said Michael Cudzil, portfolio manager at Pacific Investment Management Co. The Treasury’s quarterly refundings are when note and bond auction sizes are adjusted if necessary.

–With assistance from Cecile Gutscher and Ye Xie.

(Adds market reaction to minutes from FOMC meeting.)

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