By Ven Ram, Bloomberg reporter and Markets Live commentator
The dynamics that spurred Treasury yields higher in the first quarter have paused for now, suggesting that the next wave of selling may have to wait for a rebound in real yields and inflation pricing. Treasury 10-year yields have stalled around 1.60% after inflation expectations moderated, while real rates and term premiums declined, stealing the impetus from bearish expressions on long-dated bonds.
A simulation based on factors such as real rates, inflation expectations and expected economic growth suggests that 10-year real rates and 5y5y swaps need to climb by 30 basis points each from Monday’s close for the key nominal yield to approach 2%.
Real yields, which surged more than 45 basis points in the first quarter, have since retreated. The pace of increase through March -- the fastest since 2016 when the Federal Reserve was tightening rates -- proved unsustainable, raising the question of whether real rates will climb back into positive territory anytime soon. Remember that the key rate was well above 0% as recently as last year, before the pandemic struck.
Real rates are now near the lowest they have ever been, both in absolute terms and in relation to forecast economic growth. The gap between this year’s forecast GDP growth of 6.50% and the 10-year real rate is about 736 basis points, the widest it’s been in Bloomberg data going back nearly a quarter of a century.
Meanwhile, term premiums have also declined, eroding the compensation needed to adjust for maturity differences and underscoring why yields have retraced.
While expectations for price pressures have moderated, they seem to have the scope to climb at a quicker pace than real rates should realized inflation continue to print higher....