By Daniel Kruger
The yield on the 10-year U.S. Treasury note approached 3% Monday, hitting a multiyear high as investors bet that a pickup in inflation and economic growth would erode the value of government debt.
The yield on the benchmark 10-year note, which influences borrowing costs for consumers, corporations and local governments, rose for a fourth straight session, reaching as high as 2.996% in early trading before settling at 2.973% -- its highest closing level since January 8, 2014. The yield was 2.949% Friday. Yields rise as bond prices fall.
Monday's yield gains came after the National Association of Realtors said existing home sales climbed 1.1% in March from the previous month to a seasonally adjusted rate of 5.60 million, topping the estimates of economists surveyed by The Wall Street Journal. Signs of economic growth tend to erode the value of bonds by increasing the appeal of riskier assets.
The 10-year yield has climbed toward 3% this year, lifted by the Federal Reserve raising interest rates and investors' increasing confidence in economic growth and the prospects for a tickup in inflation. It is a climb that stalled out as the yield approached the milestone in late February, leaving investors wondering if the latest rise is sustainable.
Investors and analysts have pointed to signs of inflation as one factor behind the yield's gains, particularly rising prices for commodities, including oil, and trade tensions with China. Inflation threatens the value of government bonds by eroding the purchasing power of their fixed payments and can spur the Fed to raise interest rates.
Indeed, investors are increasingly betting the Fed has is preparing to raise interest four times this year, more than the three that officials initially penciled in at their meetings in December and March. Fed funds futures, used by investors to place bets on central bank policy, late Monday suggested a 48% probability the Fed raises rates three more times this year, up from 33% a month ago, according to CME Group data.
"It was a confluence of factors that, combined, conspired to produce a move higher in yields," said Christopher Sullivan, chief investment officer at United Nations Federal Credit Union. "It's occurred relatively rapidly."
While rising bond yields can reflect growing confidence in the economy, that hasn't been apparent in the difference between short and longer-term rates. As the 10-year yield has climbed, Fed rate increases have been driving two-year yields higher at an even faster pace. That has narrowed the gap between the two yields to about 0.5 percentage point, down from 1.25 percentage points at the end of 2016.
The so-called yield curve, which measures the spread between short- and long-term rates, is a key indicator of sentiment about the prospects for economic growth. Two-year yields tend to rise along with investors' expectations for tighter Fed interest-rate policy, while longer-term yields are more responsive to sentiment about prospects for the economy.
The narrowing gap between the two yields reflects investors' confidence that the Fed will maintain its current pace of interest-rate increases despite continuing skepticism that growth will break out of its postcrisis torpor.
Because short-term rates have exceeded longer-term rates before each recession since at least 1975 -- a phenomenon known as an inverted yield curve -- investors become wary as the curve flattens. Yet the flattening has occurred while economic growth continues to be steady, and few analysts see signs of any imminent slowdown.
Some analysts expect higher yields to attract investors back into bonds. Others have suggested that the climb could accelerate with increasing confidence in the economic outlook.
While "there's an argument to be made either way," it appears "there are investors waiting for 3% to buy," said Ian Lyngen, head of U.S. government bond strategy at BMO Capital Markets.
The low-interest-rate environment in the rest of the world is likely to slow any rise in U.S. yields, by making U.S. debt more attractive than bonds from other countries. The 10-year yield on sovereign debt is 0.633% in Germany, 0.057% in Japan and 1.534% in the U.K., according to Tradeweb.
"We think it's premature this year for huge moves, because we still have low rates elsewhere," said Michael Cloherty, head of interest-rate strategy for RBC Capital Markets.
Investors will get a new read on the U.S. economy Friday when the Commerce Department releases its initial estimate of economic growth in the first quarter. Economists surveyed by The Wall Street Journal are forecasting a 2.1% rise in output, compared with a 2.6% increase in the last three months of 2017.
While higher yields have the potential to act as a drag on growth by making it more expensive for consumers and companies to borrow, investors said they don't yet perceive higher borrowing costs as a significant economic risk.
The yield's climb to new 2018 highs came ahead of heavy schedule of government bond auctions. The Treasury plans to sell $113 billion of notes this week, and $116 billion of short-term bills. The government increased its longer-term note and bond issues by $42 billion for the months of February through April, and analysts expected a similar increase for the next three-month period. The initial note offering is scheduled to be a $32 billion sale of two-year Treasurys on Tuesday.
The rise in yields to 3% would be "a really big deal," said Thomas di Galoma, head of Treasury trading at Seaport Global Holdings. The "general angst about the growing deficits we're going to see in this country has gotten people turned around" and could lead to a 3.5% 10-year yield this year, he said.
Write to Daniel Kruger at [email protected]