The Treasury selloff that started the year is rippling across the globe as investors scramble to price in the risk that the Federal Reserve raises interest rates faster than currently anticipated to contain inflation.
Yields on U.S. 10-year notes climbed to 1.73% on Thursday, just shy of the 2021 high of 1.77%. The yield has spiked 22 basis points this week, set for the steepest increase since June 2020. The jump sparked a sell-off in bonds and equities across Asia and Europe, and widened divergences in rate expectations across markets.
“Gone are the days investors bought bonds with their eyes closed, confident in central banks’ eventual support for the market,” wrote Padhraic Garvey, head of global debt and rates strategy at ING Groep. “A key driver is a Federal Reserve on a mission to tighten policy, and the latest minutes show they mean business.”
Federal Open Market Committee members also discussed starting to shrink the central bank’s swollen balance sheet soon after their first hike, the minutes showed. That would be a more aggressive approach than during the previous rate-hike cycle in the 2010s, when the Fed waited almost two years after liftoff to begin trimming the stockpile of assets built up as it injected cash into the economy.
“These minutes are very hawkish, and it shows an FOMC that wants to lean against the market big time,” said George Goncalves, head of U.S. macro strategy at MUFG. “The bond market still views policy tightening being primarily conducted through the front end,” which may mean that short-dated yields will lead the way higher until plans for shrinking the balance sheet come into focus, he said.
European and Asian bond markets followed Treasuries lower. Germany’s 10-year borrowing costs jumped to the highest since May 2019, while Japan’s equivalent climbed to the most since April 2021 and similar yields in Australia headed toward November highs.
In rates markets, there’s growing conviction that the Bank of England will join the Fed in a tightening cycle, which the European Central Bank is expected to trail. That has widened the gap between two-year U.K. and German yields toward the most since 2018.
Money markets are now pricing in around one percentage point of BOE rate hikes by the end of this year, compared with less than 15 basis points by the ECB over the same time frame. Conviction in faster BOE tightening was somewhat buoyed by equivalent bets after Fed minutes prompted traders to cement wagers that the U.S. central bank will raise borrowing costs by a quarter-percentage point by May.
U.S. government bonds lost about 1% on Monday and Tuesday alone, adding to the 2.3% decline in 2021 that marked the worst year since 2013, according to data compiled by Bloomberg.
The already bearish mood was reinforced by the release of the minutes from the Fed’s December meeting, when it decided to conclude its monthly bond purchases by March, paving the way for raising its overnight benchmark rate.
The minutes also sharpened investors’ focus on the Fed’s balance-sheet decision as policy makers debated how the reduction of the central bank’s assets will intertwine with rates policy and how that may impact the shape of the curve. Fed Governor Christopher Waller said last month an early start to shrinking the balance sheet means “you don’t have to raise rates quite as much.”
The Fed’s balance sheet has doubled in size to more than $8 trillion since March 2020, when the central bank resumed buying Treasuries and mortgage-backed securities, first to stabilize the market and then to provide additional support to the economy as it held the policy rate at the zero bound.
“The FOMC minutes indicate Fed wants rate hikes sooner or at a faster pace, earlier balance-sheet runoff, and desire for steeper yield curve,” said Ray Sharma-Ong, investment director for multi-asset solutions at abrdn in Singapore.
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Bloomberg’s Edward Bolingbroke, Payne Lubbers, Ye Xie, Lilian Karunungan, Garfield Reynolds and Greg Ritchie contributed to this report.