The bond market suffered its worst one-day decline in eight years on Friday, with the yield on the 10-year Treasury note rising a quarter of a percentage point following the strong March employment report, according to J.D. Steinhilber, founder of ETF newsletter and investment management firm Agile Investing. He continues:
Intermediate-term yields have risen almost a half point in the past two weeks.
The bond market may be reenacting its performance of last summer when the 10-year Treasury yield rose 50% in less than three months. Between June 13 and September 2, 2003, the 10-year Treasury yield rose from 3.1% to 4.6%, and fixed-income investors learned that stocks aren’t the only investments that can suddenly lose 10% of their value.
The spike in yields last summer should not have been surprising. In the first half of 2003, yields became excessively depressed due to a sluggish post-bubble, post 9-11 economy, the war in Iraq, and a heavy dose of rhetoric from Greenspan and Co. about the threat of deflation and the possibility of the Fed buying Treasury bonds in the open market. By Labor Day, conditions were very different. The Fed had recanted its suggestion of unconventional policy measures, the war was over, and the economy was is strong recovery mode. In fact, it was in the process of registered its fastest rate of GDP growth in 20 years.
What was surprising was that after peaking around Labor Day, yields began to trend back down, despite accelerating economic growth and a host of factors traditionally negative to the bond market, including a falling dollar, soaring commodities prices and huge budget deficits. After reaching 4.6% on September 2, the 10-year Treasury yield traded between 4% and 4.5% through February 2004 and then in early March actually broke below 4% and fell all the way back down to 3.6%.
The strength of the bond market in first quarter of 2004 defied the expectations of strategists, who underestimated two key underpinnings of bond prices – massive buying by Asian central banks (which are motivated by currency and trade issues rather than investment merits) and the prevalence of yield-curve traders taking advantage of the ability to borrow short-term at 1% and invest intermediate-term and long-term at 3%-5%. Both of these forces will continue to support bond prices, although likely to a lesser degree. The yield-curve traders will recognize that with pressure building on the Fed to raise rates, time is running out on the so-called “carry trade.