Keeping the bond market vigilantes at bay
Central banks pushed back against the recent rise in Government bond interest rates and bond volatility, led by higher real interest rates.
The bond sell-off, with the 10-Year UST yield crossing 1.60% on Thursday, before pulling back to 1.40%, brought anxiety among investors, with major equity indices experiencing daily losses of 2% to 4%.
The Reserve Bank of Australia (RBA), since March 2020, has targeted the 3-Year AGS under its Yield Curve Control policy, initially to around 0.25%, and since November 2020, to around 0.10%. In the past week, the RBA purchased the benchmark AGSs (April 2023 and April 2024) for the first time since early December through a cumulative A$ 4 billion envelope, to contain Government borrowing costs, now owing circa A$ 30 billion of these two issues out of A$ 67 billion outstanding.
The European Central Bank’s Chief Economist P. Lane, reiterated that the bank is closely monitoring the evolution of, inter alia, longer-term nominal yields, in order to preserve favorable financing conditions. At the same time, the ECB Executive Board member I. Schnabel highlighted that monetary policy will have to step up its level of support (QE) if a rise in real long-term rates, even reflecting improved growth prospects, occurs at the early stages of the recovery.
All told, the ECB could accelerate its PEPP program, with a total envelope of €1850 billion, from its current pace of €20 billion per week to counter any undesired tightening of financial conditions.
Federal Reserve officials were less concerned by recent bond market volatility. Note, however, that the outlook for growth and inflation is more favorable relative to the euro area, justifying a more measured rhetoric by Fed officials vis-à-vis the recent upward move in yields.
Indeed, the Atlanta Fed GDPNow model points to annualized growth of +10% in Q1:2021 from +4.1% in Q4:2020. Moreover, the ISM manufacturing survey surpassed expectations in February by a wide margin, increasing to 60.8 from 58.7, albeit with supply-chain disruptions boosting the headline index artificially, to some extent.
Moreover, improved medium-term US growth prospects reflect expectations for significant fiscal support. In that context, the House of Representatives has passed the Biden administration’s $1.9 trillion (9% of 2019 GDP) American Rescue Plan, sending it to the Senate, with Democrats aiming to have a bill signed into law before mid-March.
Overall, US benchmark equity indices (S&P500, Dow) have declined by less than 2% from their February peaks, with the Nasdaq100 underperforming slightly. With equity valuations remaining very high (S&P500 12-month forward Price/Earnings ratio: 21.6x) partly due to extremely low real interest rates, a disorderly rise in Treasury yields could initiate a sustained period of elevated equity market volatility.