10 Year Treasury Prices Soar 10%


Rotation to safety, or change in market outlook?

U.S. government bonds have been selling off for the majority of 2022. There are a few narratives behind why this may have been happening.

First, the yield on treasuries of various lengths has stayed close to historical lows of around 2%. This essentially means that if you buy a treasury for $1000, you can expect to be paid around $20 annually in interest over the term of the bond. This stable and predictable return has been the foundation of many different investment portfolios. Traditional investors would even make arbitrary allocation standards for themselves like the 60/40 portfolio, which is a mix of 60% stocks and 40% bonds. The problem with this today is that if inflation as measured by CPI is hovering around 8%, holding an asset which yields 2% annually is actually generating a real loss of 6%. This is a very unattractive deal, and puts retirement and pension funds in a very difficult position. Retirees start needing inflation based income adjustments, but with negative yielding investments it is very hard to pay them out without destroying the funds principle.

Secondly, the freezing of Russian foreign exchange reserves and assets like treasuries has been a wake up call for nations with goals which differ from the United States. Counter-party risk was never something seriously considered when it came to U.S. debt. Treasuries have been a safe haven asset historically due to the belief that the United States could never default on its debt. While technically not a default, the seizure of those reserves demonstrated that there is risk in holding our debt. Smart central banks and government planners will be looking to hold more reserves in gold, baskets of currencies, and other bearer assets. The promissory contract of a bond needs to be treated as what it is: an agreement between two parties which relies on trust.

Lastly, the biggest buyer of U.S. Treasuries is currently leaving the market, and getting ready to transition to selling. That buyer is the Federal Reserve. They have tried to taper off their balance sheet before, but have never done it successfully and have always ended up having to reverse course and buy more treasuries than they sold. Notably, Japan is also transitioning from being a buyer to a seller. Japan is the biggest sovereign holder of U.S. debt, with well over 1 trillion worth of treasuries on their balance sheet.

Those narratives contribute to the majority of the poor performances of U.S. debt this year. But now comes the interesting part. Consider this. If you knew that someone had to sell something, how much would you pay for it?

Any rational actor would clearly ask for a discount on the price of a good which they know someone needs to sell at any price. That is part of why there had been a selloff in markets, as they factor in the future selling of bonds by the Fed and other assets by those who need dollars. That logic is part of the forward looking nature of markets. They anticipate who would want to buy or sell into the future, and then try to price in that anticipated increase or decrease in net selling. And that is why it is so interesting that the 10 year treasury went up 10% in a single day. While not the full picture, this type of price action doesn’t make a lot of sense if the market fully expects a lot of sellers in the future. And after reviewing the fundamentals of treasuries, who could have enough capital and will to move the market in such a way other than the Fed themselves?

Graph: US 10 Year Bond Prices Jump 10% in one day.

I am by no means suggesting the Federal Reserve has re-entered the market as a buyer. They are still in the part of their cycle where they need to act as though they are combatting high inflation, and directly monetizing debt would be an action opposed to that goal. But what this does suggest, is that the markets anticipate there will be big buyers in the present and future. With households, corporations, and countries scrambling to get their hands on U.S. dollars to pay back debts and sending the DXY to multi-decade highs, the only buyer big enough to warrent this type of move is the Federal Reserve. I anticipate markets have and will begin pricing in a Fed reversal, and that when purchases finally do start being made again, the control of the yield curve will be systematic and extremely thorough.

This is all fairly dubious speculation, but this type of a move in the bond market is very unprecedented. It is incredibly important to watch the debt markets. When the reversal comes and the buying begins, the increase in the money supply will send prices of everything sky high, and the system of bad credit will begin to unravel.