Saqib Iqbal Ahmad

NEW YORK (Reuters) – The Federal Reserve’s hawkish tilt has shaken up the bond market, with Treasuries recording their worst start to the year in history.

The yields on the benchmark U.S. 10-year Treasury reached an all-time high of 2.417% this week, as investors factored into a more aggressive Fed. This is a 90 basis points gain from the start of the year, and the highest since May 2019.

As inflation rises, many investors anticipate more volatility in bonds. Goldman Sachs (NYSE:) on Thursday raised its year-end forecast for the 10-year yield to 2.7% from an earlier projection of 2.25% and predicted a “modest” inversion of the Treasury yield curve, though the bank’s analyst said the phenomenon would not necessarily be indicative of an oncoming recession, as it has in the past.

Below is a brief overview of where the Treasury Market stands nearly three months prior to 2022.

Graphic: Bonds bleed- https://graphics.reuters.com/USA-MARKETS/BONDS/klvykjgmovg/chart.png

The ICE (NYSE 🙂 BofA Treasury Index fell 5.6% this year. This is its worst start in its history. It was revalued by investors as a Fed which is expected to raise monetary policy by 190 base points next year. However, it has indicated that they could increase rates by 50 basis point at one of their upcoming meetings if needed.

Graphic: Yield curve inversions and recessions- https://fingfx.thomsonreuters.com/gfx/mkt/lbvgnmgzzpq/Pasted%20image%201648064675503.png

Investors who are concerned about hawkish monetary policies affecting growth should be looking at the Treasury yield curve. This has been showing yields for some debt with a shorter maturity increasing above those of longer-dated debt.

A distorted yield curve indicates that investors worry about the economy. Receipts often follow when yields of 2-year Treasuries rise above those on 10-year Treasuries. This part of the yield curve is not yet inverted. However, the gap between the yields has been shrinking in recent weeks.

Goldman Sachs analysts said that they expect a part of the yield curve will invert this year. However, such an event would not be interpreted as a signifying a recession because of current high inflation.

“In such an environment, a deeper nominal curve inversion may be needed to produce the same recession odds in models as seen in more recent business cycles,” Goldman’s analysts wrote in a recent report.

Graphic: Real yield- https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkdjozpx/Pasted%20image%201648069055243.png

Also, investors have been closely monitoring so-called real yields. This is the nominal yield on a bond that has fallen below the inflation rate.

Negative real yields on Treasuries have burnished the attractiveness of stocks and other comparatively risky assets for more than two years, helping to underpin the S&P 500’s doubling from its March 2020 lows. However, they are now moving higher due to the Fed’s growing hawkishness. This could signal more trouble for the Fed, currently at 5.2%.

Graphic: Bond bets- https://fingfx.thomsonreuters.com/gfx/mkt/movanbjkapa/Pasted%20image%201648131929150.png

As geopolitical uncertainty rose after Russia’s invasion of Ukraine, investors who had previously piled into Treasuries (a popular safe-haven) likely felt the brunt of this selloff. The TLT iShares 20+ year Treasury bond ETF – often used by investors to express views on the government bond market – saw net inflows for the last six weeks, the longest streak in three years.

Graphic: Speculative positioning: https://fingfx.thomsonreuters.com/gfx/mkt/lgvdwqkaqpo/Pasted%20image%201648064963248.png

However, other segments appear to be better positioned than others for greater yields. The CFTC data for Treasury futures shows that investors are in a net short position since October. This is based on positioning of hedge funds and shorter-term participants.