Bond markets have been in a frenzy since Powell and the Fed signaled higher for longer interest rates at last month’s FOMC meeting.
AP Images / Richard Drew
The chaos in bonds has largely been spurred by the Fed, according to Wall Street experts.
Some say the selloff in long-dated Treasurys was sparked by panic over higher-for-longer interest rates.
But interest rates are unlikely to stay this high for long, according to Fundstrat’s Tom Lee.
The Federal Reserve has sowed panic among investors and that’s led to the latest bout of dysfunction in the bond market, Wall Street experts say.
Chaos in US government bonds has become the top concern for markets over the past few weeks, with the yield on the 10-year US Treasury recently notching a 16-year-high. That’s as markets reset and come to grips with the reality of higher-for-longer interest rates, which Fed Chair Jerome Powell drove home for investors at the September FOMC meeting. It’s also partly a function of fears related to the mounting US debt balance and the possibility of a recession barreling towards the economy.
But according to some market experts, the selloff is largely fueled by feelings of panic in the market rather than fundamentals.
This was on display as investors rushed to dump long-dated bonds after hearing Powell speak at the Fed’s last policy meeting, according to JPMorgan Asset Management’s chief investment officer Bob Michele.
“I think for a long time the market thought the Fed was raising rates at a pace that something would break – and it did, the regional banking system,” Michele said in an interview with CNBC on Thursday, referring to the banking crisis set off by collapse of Silicon Valley Bank earlier this year.
That event sparked hope the Fed would soon pause interest rate hikes to prevent sowing more chaos. That hope didn’t last though, as Powell and the Fed not only kept raising rates but have signaled at the last FOMC meeting that they would remain higher for longer than markets were previously expecting.
“Coming out of the last FOMC meeting two weeks ago, I think that’s really when the bond market broke down,” Michele added. “The rhetoric coming out of the Fed the last two weeks has been uniform: it’s not only higher for longer, it sounds like higher forever.”
High interest rates have put pressure on all corners of the economy and have caused investors to fear that the odds of a recession are on the rise.
“This is clearly a panic attack,” market veteran Komal Sri-Kumar said to CNBC on the selloff in bonds. “The panic attack came, I believe, because [investors] essentially found that the Fed was not responding to the increase in interest rates, and suddenly they piled on each other to sell the bonds.”
Severed from fundamentals
But it’s also possible that the surge in bond yields is disconnected from some fundamentals of the market. The US debt balance, for one, has worried economists for years, and markets have been eyeing a possible recession since early 2022, meaning none of the fears investors appear to be responding to in the last month are new or unfamiliar.
And though the US 10-year bond yield is higher than that of other countries, like Spain or Germany, US inflation is lower by comparison, Fundstrat’s Tom Lee notes.
“To me, maybe this is another example of how there’s been a lot of momentum pushing yields higher, but it may be divorced from fundamentals,” Lee said in a video to Fundstrat clients on Wednesday.
The good news is that rates are unlikely to stay high for this long, he added, especially when looking at cooling inflation indicators. By some measures—like shelter prices—inflation is dropping like a rock. That could influence the Fed to dial back rates sooner than markets are currently anticipating, which could allow bond yields to ease.
The yield on the 10-year US Treasury note traded around 4.719% on Thursday, its highest since 2007. Meanwhile, markets think there’s an 80% chance the Fed holds rates unchanged at its meeting in November, and see nearly a 97% chance that it will cut rates by the end of next year, according to the CME FedWatch tool.