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A deepening crash in the bond market has sparked panic on Wall Street in recent weeks.
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Treasury prices have plummeted, sending benchmark 10-year yields above 5% for the first time in 16 years.
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Here’s what the market meltdown means for stocks, the economy, and ordinary people.
To the average American, the word ‘bond’ might suggest an Eton-schooled MI6 agent who takes his Martini shaken, not stirred, rather than the far-from-sexy financial investment favored by boomers.
But in recent weeks, the asset class has hit headlines by suffering one of the worst routs in market history, in a sell-off that’s ringing alarm bells on Wall Street.
The collapse ticked off a new milestone Monday, when yields on 10-year US Treasury notes topped 5% for the first time in 16 years. Yields move inversely to bond prices.
Here’s what the meltdown means for your investments, the economy, and your wallet.
What are bonds, Treasurys, and yields?
Big-name investors, Wall Street bankers, and financial journalists tend to use lots of unnecessary jargon when they talk about bonds – and anybody who isn’t a markets junkie tends to find that pretty off-putting.
To lay things out as simply as possible:
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Governments and companies issue bonds when they want to borrow money. If you buy a bond, you’re giving them a loan. The bond itself functions as an IOU note, with the holder entitled to regular interest payments and repayment of the loan in full at a later date. Unlike traditional loans, the ownership of bonds can be easily transferred – meaning, they can be freely traded in a secondary market.
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Bonds issued by the US government are called Treasurys. Ten-year Treasurys function as a benchmark for that market and help set the price of other loans and investments.
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Bond yields are the interest-rate returns a holder can expect, as a proportion of their capital investment. They’re expressed as a percentage.
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Bonds may be issued for different time periods – or maturities – depending on the borrower’s funding requirements. The longest maturity period in US Treasurys is 30 years.
Longer-term Treasury yields have been rising steadily since the pandemic. In recent weeks, that sell-off has rapidly accelerated and turned into one of the worst routs in the history of the US bond market.
Remember, yields move in the opposite direction to bond prices – so the massive spikes of the past few weeks mean that Treasury prices are tumbling, fast.
What’s driving the bond-market meltdown?
Two factors have fueled the recent run-up in yields: the Federal Reserve, and the US government’s ever-growing mountain of debt.
Over the past 18 months, the Fed has raised benchmark interest rates by more than 500 basis points – the steepest increase since the 1980s. In recent months, the central bank has signaled it plans to keep rates high well into 2024 in a bid to kill off inflation, which has cooled this year but is still running way clear of the central bank’s 2% target. When borrowing costs go up, bond prices fall because their fixed returns become less attractive to investors.
Chair Jerome Powell said last week that the Fed plans to proceed “carefully” with its monetary-tightening campaign – but the majority of traders aren’t expecting any reductions in rates until June at the earliest, according to the CME Group’s FedWatch tool.
Lingering concerns about America’s ballooning indebtedness have also contributed to the sell-off.
The US government’s outstanding borrowings have tripled over the last two decades a staggering $33.64 trillion, official data show. That dwarfs the world’s largest economy’s GDP of around $27 trillion.
The debt has surged by $640 billion in the past five weeks alone, suggesting an accelerated supply of bonds and bills that’s threatening to overwhelm demand. In other words, the slump in bond prices suggests the Treasury is selling debt faster than the market is able to absorb it.
Why does any of this matter?
First, the rapid rise in bond yields is bad news for stocks.
Equities started this year on an AI-powered tear but that rally has fizzled out in recent months – and juicier debt-market yields, coupled with worries about higher-for-longer interest rates, have been one factor that’s fueled the slowdown.
That’s because when yields are higher, there’s more incentive for investors to pivot to bonds, lower-risk assets that offer a higher relative rate of return.
UBS is already calling on investors to favor bonds over equities, with the Swiss bank saying last week that it expects 10-year Treasurys to outperform the S&P 500 over the first half of 2024. The benchmark index snapped its longest losing streak of 2023 Tuesday, after finishing in the red five days in a row.
Any major moves in the $51 trillion US Treasury market also raise the risk of a period of heightened volatility that could bring further pain for stocks. Silicon Valley Bank collapsed back in March after disclosing major losses on its bond portfolio, sending benchmark indices plummeting and triggering turmoil that led to the failure of several other regional lenders.
Second, higher bond yields can have a knock-on effect on the economy and ordinary Americans.
Because Treasurys are a debt obligation to the US government, they’re considered to be one of the safest investments around – making 10-year yields a de-facto benchmark for lenders.
So, when yields spike, interest rates on other things – from mortgages, to personal loans, to credit card bills – are all likely to rise as well, as they have done over the past few months.
Higher benchmark Treasury yields also make it more expensive for companies to borrow cash, increasing the risk that firms have to lay off employees in order to slash their costs.
Most people tend to find the bond market a snoozefest – because fixed income is wrapped up in unnecessarily complicated jargon and tends to offer pitiful returns compared to other assets like stocks and real estate.
But with mortgage costs and unemployment rates likely to rise, and equities primed to tumble, maybe it’s time to start paying it a bit more attention.
Read the original article on Business Insider
Source: finance.yahoo.com