The selloff in the bond market isn’t showing much sign of letting up.
10-year Treasury yields have pushed up to 5.18%, extending the breakout above 5% and putting another important technical area firmly into view. The next major hurdle on the chart sits around the 5.25% to 5.30% region, roughly where yields topped out during 2006-07.
So, what’s next from here?
Well, if the 2006-07 highs give way, I reckon the conversation around 6% Treasury yields will then start becoming a lot less theoretical. It’s a level that is in the back of everyone’s mind right now but how plausible is it really?
The way I look at it is that it is important to be reminded of the fact that the fundamental forces responsible for the break above 5% haven’t really gone away.
Oil prices remain elevated, inflation concerns continue to linger and US economic activity continues to hold up better than markets might have expected. Adding to that is a more hawkish tone presented by the Fed, with policymakers increasingly focused on the risk that strong demand itself is keeping inflation sticky.
Besides that, you have the structural issue that is sitting underneath everything else. That being the mounting worries over the US fiscal outlook. The ballooning deficit means that investors are being asked to absorb a chunk of government debt in a time that inflation uncertainty is demanding a higher premium for owning longer-duration bonds.
Of course, this doesn’t mean that we are going to see yields go straight to 6%.
The 5.25% to 5.30% region will still mark the first key test, with higher yields themselves could eventually tighten financial conditions enough to slow the economy. But let’s not take it all too lightly. The chart definitely is beginning to look rather uncomfortable.
For now, I wouldn’t treat 6% as the base case. But if 5.30% breaks while inflation, oil, growth and fiscal concerns keep moving in the same direction, suddenly talk of 6% is something markets will have to take more seriously rather than dismiss outright.
This article was written by Justin Low at investinglive.com.