The Treasuries Massacre and Soaring Mortgage Rates to 5%: It’s All Going Very Fast
Junk bonds are still in la-la-land though, Apocalypse just not now.
By Wolf Richter for WOLF STREET.
When investors demand higher yields on bonds, motivated sellers must lower the price of those bonds in order to sell them. And yields are soaring and the prices of longer-dated bonds are plunging.
One-year Treasury yield rose 38 basis points during the week, including 12 basis points on Friday, to 1.67%, the highest since October 2019. There is now a huge gap of 150 basis points between the a month yield of 0.17% and the one year yield of 1.67%:
It’s a hell of a fast-moving train. And the Fed hasn’t even done much other than a small rate hike and a lot of talk about what it’s going to do, which is to raise rates much faster and farther than we think. previously imagined, and launching quantitative tightening “as soon as” may finally repress inflation, which is now spiraling out of control. And credit markets got the memo.
The two-year Treasury yield rose 33 basis points during the week, including a massive 17 basis points on Friday, to 2.51%, the highest since April 2019.
The volatility of the two-year return is huge, the worst since the financial crisis, with massive peaks interrupted by some modest declines. This chart shows the daily changes in the two-year yield in basis points. The largest one-day spike in this cycle, 25 basis points, occurred on February 10:
The 10-year Treasury yield jumped 34 basis points during the week, including 14 basis points on Friday, to 2.48%, the highest since May 2019.
The 10-year yield has been rising since the low point of 0.52% on August 4, 2020, which marked the top of the biggest bond bull market ever launched in October 1981. At the time, the 10-year yield had reached a peak. at 15.8%, after CPI inflation peaked in April 1980 at 14.6%.
Beginning in October 1981, yields zigzagged lower, interrupted by sharp rises in between, and since 2008 driven lower by the Fed’s interest rate crackdown and massive QE. Now the result is the highest inflation since 1981, with February CPI at 7.9% and worse inflation ahead.
The dollar bond massacre. Market prices for long-dated bonds are ravaged when interest rates rise.
For example, the price of the iShares 20 Plus Year Treasury Bond ETF, which holds Treasury bills with maturities of 20 years and over, fell 1.4% on Friday to $128.66. This is down 25% from the peak at the end of July 2020. The 40 years of bond market bulls have lull people to the risks of bond funds.
But not yet the junk bonds. This slaughter is playing out with Treasuries and with higher quality corporate bonds, especially the top-rated corporate bonds that closely track Treasuries.
Yields on junk bonds have slowly risen since last summer’s low point, and spreads over Treasuries have slowly widened. But since March 15, when all hell broke loose in the Treasury market, junk bond yields have actually fallen and remain historically low, and their spreads have narrowed and are historically narrow.
This means that the market is still not paying attention to the credit risk of companies – the risk of default – and the market is still chasing the yield and continuing to give those rotten rated companies with a significant probability of default a pass-through risk. credit, which is going to haunt the market when it wakes up. Apocalypse but not now.
This chart shows the average yield of B-rated high-yield bonds. A “B” rating is roughly in the middle of the junk bond range (here’s my cheat sheet for corporate bond credit ratings and what they mean in plain language):
The yield curve is now very steep from the one-month yield (0.17%) to the three-year yield (2.51%). But then it flattens out across the seven-year yield, reverses a tiny bit at the 10-year yield, then steepens at the 20-year yield, then reverses again at the 30-year yield.
The yield curve still says nothing about the economy, because it is still an artificial construct manipulated by the Fed: the Fed still suppresses the short end of the yield curve with its key interest rates, and its obese balance sheet sits at the top and crushes the long end of the yield curve. At some point, QT, once it reaches critical mass, will start to free the long end of the yield curve, and long-term yields will rise much more, the curve will steepen at the long end.
The chart also shows the yield curve as of August 4, 2020 (in green), marking the end of the 40-year bond bull market, to be cut out and stuck on the fridge with a wistful nostalgic smile:
Mortgage rates, Holy Moly. On Friday, the average 30-year fixed mortgage rate hit 4.95%, the highest since November 2018, according to Mortgage Daily News. And once it tops 5.15%, it would be the highest since before the financial crisis. But back then, and in 2018, house prices were much, much lower. Already, layer upon layer, buyers are moving away from the market at these mortgage rates:
But as the saying of WOLF STREET goes, “nothing goes wrong in a straight line”. It is very likely that Treasury yields will pull back a bit, after this surge. And hedge funds that run out of Treasuries – the most obvious evidence in human history – are going to get beaten up. It’s always like that. One thing we know: it’s going to be volatile, with massive moves in both directions. And the 5% mortgage rate is kind of the sound barrier, and it will take some time to significantly break through. But its impact on the housing market is already being felt.
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