The mystery of spiking Treasury yields
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Technical mechanics are one factor behind the spike in rates that's got the typically boring government bond markets on edge — and a reason we might be living in a higher interest rate world for a while.
Why it matters: The Treasury market is the plumbing of the world economy and, much like the pipes in your house, when it gets jammed up you have to pay attention.
By the numbers: The interest rate on the 10-year Treasury note touched levels last seen in 2002 on Thursday, before easing back to 5.24%, and 30-year bonds are also sitting at multi-decade highs.
- The average rate on the 30-year mortgage, which tracks the 10-year Treasury, surged to 7.28% up from 7.03% last week, Freddie Mac said Thursday.
- The surge in rates on U.S. Treasuries is feeding on itself as institutional investors that typically buy government debt have instead been selling, forcing rates up further.
What they're saying: "The shizzle has hit the fan," says Yesha Yadav, a professor of law at Vanderbilt who specializes in Treasuries market structure.
Between the lines: Big macro forces — war in Iran — and rising deficits have driven rates higher, but another part of what's happening is a more technical matter of supply and demand. The rising rates have turned some typical buyers of Treasury bonds — particularly hedge funds and mortgage REITs — into sellers.
- That means there is less demand for the bonds, so prices fall. And when prices on bonds fall, the interest rates those bonds pay to investors rise.
- The rub: When rates rise, then there's more selling.
Zoom out: "It's almost like you're running like a hamster just to stay at the same place," Priya Misra, a portfolio manager at JPMorgan Asset Management, tells Axios.
- "If nothing else happens this thing feeds on itself," she says.
The intrigue: The big driver of this selling is coming from institutional investors that hold mortgage bonds.
- When rates rise fast, these bond holders must change the way they hedge their investments, often by selling Treasuries or other derivatives.
- "We're dealing with that on a daily basis," says Misra.
This mortgage convexity dynamic is the main technical factor behind the sell-off, says Amrut Nashikkar, head of interest rate derivatives research at Barclays.
- The Fed was once the biggest buyer of mortgage bonds, and it didn't hedge its interest rate risk. But it stepped back from the market in 2022, and more of those bonds now sit with private investors who do hedge.
What we're watching: Some market observers also suspect hedge funds may be unwinding what's known as the "basis trade," a way to profit on the difference between the price of an actual Treasury bond and a future on that bond. Though the evidence there is not yet clear.
Yes, but: Strong economic growth in the U.S. is also pushing up rates.
The dynamics are murky because we're talking about a $32 trillion secondary market. "You don't know in real time how things are changing hands," says Robin Brooks, an economist at the Brookings Institution.
- "The only thing we know is that in aggregate, supply is greater than demand."
The big picture: Over the past several years, the massive Treasury market has changed. Foreign governments have pulled back on buying, and private investors now make up a bigger share of the market. That means you're likely to see more gyrations and higher rates in the future.
- What's happening now "is a symptom of that structural change," says Nashikkar.
