Rising yields on 10-year US Treasuries raise risks for global economy
TEN-YEAR US Treasuries are traditionally regarded as the default risk-free asset, a convenient and reliable gauge for things that facilitate the wheels of the economy and finance. It’s a barometer of economic outlook and sentiment, for one. It’s used to price loans. For investors, it’s a handy benchmark for quick calculations of risk premiums of other assets, and also serves as ballast and stabiliser in portfolios. Has the risk-free label become a misnomer?
Earlier this week, 10-year Treasuries briefly touched 5.02 per cent, the highest level since 2007, before dropping back to 4.84 per cent. A series of Bloomberg charts chronicle the upheaval in the world’s so-called “safest” asset. A fear index for Treasuries based on one-month options has risen for five straight weeks.
Bloomberg pointed out that the 10-day volatility for an iShares exchange-traded fund (ETF) tracking longer dated bonds is more than 15 percentage points higher than an ETF tracking the S&P 500. This, it went on to say, is unprecedented. Over the past 20 years, volatility on the bond ETF has been two percentage points lower than the equities ETF.
The upheaval in the bond market is clearly spurred by the US Federal Reserve’s aggressive rate hikes to quell inflation since 2021. The surprise has been the US’ economic resilience. But of late, the divide between investors’ bets on a soft landing and the Fed’s signals that it would raise rates once more this year has roiled markets. The prospect of yet more US government debt issuance, anxieties over the US budget and dysfunction in Washington, plus Fitch’s and Moody’s downgrade of US’ credit rating earlier this year all have conspired to send yields higher.
Concern weighs heavily that higher rates would finally drag down the US economy amid elevated inflation. As credit conditions tighten, corporates would find it more challenging to refinance debt, which would in turn crimp expansion and investment plans. For individuals, higher rates spell more costly debt, ranging from credit cards to mortgages. Freddie Mac’s 30-year fixed rate mortgage hit 7.3 per cent at end-September, the highest rate since 2000. These factors are likely to rein in consumer spending.
Not surprisingly, higher Treasury yields have reverberated, not just in the US but also globally. Equities have suffered a valuation hit as rates impose a higher hurdle for returns. Returns on the S&P 500 remain positive year to date, but the index has lost more than 2.8 per cent over the past five days. Yields on 10-year government debt in markets such as the UK, Germany and Germany have also climbed. The International Monetary Fund’s (IMF) latest Global Financial Stability Report warns that the global credit cycle has started to turn, and risks to global growth are skewed to the downside.
Not far from mind is the impact of higher rates on global banking. To be sure, banks benefit from the ability to charge higher rates on loans. But they also hold significant debt securities on their balance sheets. These securities lose value when rates rise, raising the spectre of failures similar to Silicon Valley Bank.
The IMF, using enhanced stress-testing tools, says its study of 900 lenders across 29 countries shows the banking system is “broadly resilient”. That is surely a relief. Risks abound, but for long-term portfolios which must hold fixed income assets, credit quality is paramount. Among high-quality assets – including Treasuries – mark-to-market losses are surely temporary.
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