A sharp repricing has recently plagued the government bonds markets. The 10 year US Treasury yield now sits at 1.55%, up more than 0.5% since the end of last year. The causes of this repricing have perplexed many. Let’s take a look at what might be the driving forces behind this move to understand where government bond yields might be headed next.
Background: The economy is improving
As I pointed out at the end of 2020, a move towards higher government bond yield was expected. The thesis behind that view is quite simple: We are experiencing some further improvement in economic activity. We now have more information on this, with some of the Fed estimates currently pointing to Q1 GDP increasing by as much as 8.1%.
We are also seeing a large decrease in the COVID cases and a vaccination campaign which is happening at a much faster pace than originally anticipated. As we write this, close to 80 millions doses have already been administered; growing by more than 10 million on a weekly basis.
There is also more government help on its way, as the House recently passed a $1.9T stimulus package. This represents around 10% of the GDP and should continue to provide ample tailwinds to economic activity this year.
Where to go from here?
With this economic background, it is natural to wonder where bond yields might go next. First, given the unemployment rate is still above 6%, the Fed is in no rush to raise interest rates. Furthermore despite some hint of price pressure, inflation has so far remained well contained. While we should expect inflation to move higher this year, it is still unclear how quickly it might increase.
In the shorter term, one might rely on history as a frame of reference. We can use a quantitative indicator called RSI (Relative Strength Index) which essentially measures the strength or velocity of financial asset price movement. As we can see from the picture above, the RSI for the 10 year Treasury yield is now above 75, indicating how strong the recent increase has been. Over the past thirty years, such a level has been reached only seven times. Interestingly, after most of these instances occurred the bonds sell-off actually started losing speed, and in several cases, even reversed. Examining these past trends points toward some stabilization soon in the bond markets.
The increase in government bond yields this year has surprised many and is mostly due to the welcomed improvement in economic activity. If history is a lesson, the relatively sharp recent repricing should start losing steam, and we can expect some sort of stabilization in the short to medium term.
Chief Investment Officer
Treasure Investment Management, LLC
Disclaimer: The views and opinions in this piece are just the author's own, offered to the public at large and not to any one particular investor.