Three key takeaways from the bond market turmoil – Charles Schwab

The late-February spike in US Treasury bond yields sent ripples throughout the global markets.  Ten-year Treasury yields settled at 1.4% after spiking by more than 30 basis points to a peak of 1.6%, the highest level in a year. According to economists at Charles Schwab, the days of  low volatility are likely behind us. The recalibration of yields is likely to be a bumpy process.

Key quotes

“With real yields still in negative territory, there is plenty of room for them to normalize longer term if the economy’s prospects continue to improve. Even without rising inflation, yields can continue to rise. While the Federal Reserve may try to temper the move up in bond yields, if it is too fast or appears likely to hinder the economic recovery, the trend is likely to be higher over time.”

“Short-term interest rates tend to reflect expectations for the path of the federal funds rate and usually don’t diverge that much from the Fed’s estimates. However, over the past week even two-year yields crept up a bit. More importantly, intermediate-term yields moved up sharply. The move suggests that the market is pricing in the risk that the Fed will be hiking rates sooner, and perhaps by more than indicated by the Fed’s projections.”

“The Fed has tools at its disposal to offset the rise in long-term rates. The first step likely would be more communications about why it sees the need to keep rates low. After that, it could buy more long-term bonds, and/or shift some of its purchases of mortgage-backed securities to Treasuries. It could also increase the amount of bonds it is buying.”

“Given the improving outlook for the economy coupled with a central bank willing to tolerate higher inflation, we would expect bouts of volatility ahead as markets reprice for a different environment in 2021 and beyond. Over the long-run, high yields driven by stronger economic growth are positive, but the process can be volatile.”