In the two short weeks since the Fed ended its September meeting, the 10-year yield has surged more than 50 basis points, flirting with 4.9 per cent this week. Almost every trading day, the world's major financial media will use headlines like the US bond yield "continued to hit the highest since 2007" as a selling point for news.
So what's driving the relentless sell-off in the Treasury market right now? Can US bond prices still climb out of the ongoing slump? What do Fed officials think of bond market movements?
Barclays, the world's leading investment bank, and Goolsbee, the president of the Chicago Federal Reserve Bank, on Wednesday local time, respectively, expressed their views on the current situation of the US bond market.
Barclays: Only a stock crash can save US debt
'Global bond prices are destined to continue to fall unless equity markets continue to underperform and revive the (safe haven) appeal of fixed income assets,' Barclays analysts led by Ajay Rajadhyaksha wrote in a report Wednesday.
According to the report, there is no magic yield level in the U.S. bond market - once reached, it will automatically attract enough buyers to trigger a sustained rally in bonds.
"In the short term, one scenario in which we can imagine a sharp rally in bonds is a sharp fall in risk assets over the next few weeks," Barclays argues.
The ongoing rout in U.S. Treasurys has sent shockwaves through global bond markets in recent months as investors priced in higher borrowing costs for longer. While Wednesday's sell-off abated, traders remained on high alert for renewed volatility, especially if Friday's U.S. nonfarm payrolls data came in stronger than expected.
Analysts at Barclays said the Fed is unlikely to ease its so-called quantitative tightening program, which would make it a net seller of U.S. Treasuries. In addition, the increase in bond supply due to the rising US budget deficit has also pushed up the term premium in the US Treasury market.
As net buying by foreign central banks slows, demand for Treasuries will weaken further, the report said. Japanese investors, who are currently the biggest foreign holders of US Treasuries, may prefer local bonds in the future as yields rise when the Bank of Japan adjusts its accommodative policy stance.
All of this means the fate of the Treasury market is in the hands of the stock market, according to Barclays. The S&P 500 has fallen about 5% over the past three months, but that's not nearly enough to trigger a rally in the fixed-income market, the firm's analysts wrote.
(Comparison of 10-year US Treasury yields before and after the 1987 "Black Monday" stock market crash with the current)
"The magnitude of the bond sell-off has been so striking that, from a valuation perspective, stocks are arguably more expensive than they were a month ago," they wrote. In our view, the path to eventual bond stabilisation lies in further depricing of risk assets."
Goolsbee: Timing of the sell-off is a 'mystery'
Compared with Barclays' pessimistic outlook for the bond market, Chicago Fed Chairman Goolsbee's current situation in the bond market also has its own confusion. In a recent episode of the Odd Lots podcast, Goolsbee said the timing of the sell-off was a good one. quot; enigma quot; .
Goolsbee noted that the Fed's latest quarterly economic forecast (SEP), released after September, did differ slightly from the previous one, but were those differences enough to cause such a significant shift in the market in three weeks? It's still confusing.
"I think what people are trying to figure out is, 'Why did the market move the way it did in the last three weeks? Of course, if you take a six-month view, in a way, I don't think it's a big mystery - it's clear that the rise in long-term interest rates is something that the market was already anticipating."
It is worth mentioning that the recent plunge in US Treasuries has also reignited fears that the financial system could collapse. Memories are still fresh of the run on deposits at Silicon Valley banks in March as their bond portfolios took a beating. Tighter financial conditions could also lead to a sharper slowdown than expected.
In response, Goolsbee said, "We will absolutely watch and weigh this, which could be a blow to the financial or real economy."
Goolsbee said, "If there is a credit crunch, if these things get materially worse in a way that we haven't seen in the last six months but fear we have seen, we will adjust and we have to take that into account." The Fed has a dual mandate."
Still, the relatively dovish Fed official is optimistic for now that the central bank can continue along what he calls the "golden path" of a "soft landing." Over the past year or so, U.S. inflation has fallen sharply while the unemployment rate has remained below 4%. While inflation has yet to return to the Fed's 2% target, its recent performance has been very encouraging.
Goolsbee attributed much of the improvement in inflation to the ongoing supply chain recovery, and the supply chain Stress Index suggests that there is still a lot of "disinflationary potential" in this area.
He believes the Fed's rate hikes have played a crucial role in keeping inflation expectations in check, both in survey and market data. In addition to supply chain progress, conditions in the job market are stabilizing, thanks to rising labor force participation and a return to historically normal levels of immigration.