A punitive sell-off in short-term debt is pushing a rate near ‘magic’ levels that ‘scared’ the markets

The yield on the 1-year Treasury note is testing 4%, a level that traders say could spread to other rates and send shivering through financial markets, as the Federal Reserve slashes its $8.8 trillion balance sheet. With his drive to reduce proceeds in earnest.

That balance-sheet process, known as “quantitative tightening,” is intended to complement the central bank’s series of aggressive rate hikes, one of which is expected next Wednesday. According to Mark Cabana, BofA Securities Rates Strategist, the Fed is “tightening on all cylinders now” as “training wheels” come off QT after a slow start. And traders say there’s a reason behind Thursday’s one-year yield move, which includes intermittent touching down or slightly above 4% before retreating again.

“Four percent is a magic number and one that scares many asset markets, including equity markets and basically everyone,” said John Farwell, head trader at bond underwriters Roosevelt & Cross in New York. The Fed’s QT process is one of the reasons this is happening and is “increasing pressure on the front end of the curve.”

Farwell said Thursday via phone that the Treasury market is likely to spread the 4% yield to other rates as expectations around an aggressive rate move from the Fed. “You can see what you’re seeing right now — more stress on the equity market — and you can see the equity guys exiting.”

Reading: Stock-market wild card: What investors need to know as Fed shrinks balance sheet at rapid pace

In fact, all three major US indexes, the DJIA,


ended lower on Thursday as Treasury yields continued to climb.

Data provided by Tradeweb shows that the one-year rate TMUBMUSD01Y,
New York went up a little over 4% three times during the morning and afternoon before retreating.

Source: Tradeweb

According to FactSet, the one-year yield, which reflects expectations around the Fed’s near-term policy trajectory, has not finished the New York trading session above 4% since October 31, 2007.

Meanwhile, the bond market showed more worrying signs about the outlook: The spread between 2- and 10-year Treasury rates fell to minus 41.3 basis points, while the gap between the 5- and 30-year rates declined. fell from zero to 19.3 basis points.

Financial market participants are slowly coming around to the idea that the Federal Reserve will keep financial conditions tight until some breakdown in the US economy in order to bring down the hottest inflationary period of the past four decades.

Aside from QT, the other reason for the one-year yield moving toward 4% is that traders are increasingly focusing on the level at which policymakers will end rate hikes, known as the terminal rate. , and there is concern over the possibility that one of the next Fed moves could be a 100-basis-point increase, according to one strategist.

Higher rates, especially in one-year Treasuries, benefit investors who haven’t yet had a chance to get into the fixed-income market, giving them the opportunity to achieve higher yields at lower prices. “We can see investors moving into the security of the Treasury and more players coming into the bond market. “Treasury may become a viable option for some people,” Farwell of Roosevelt & Cross told MarketWatch. He said the 1-year Treasury rate has been “partial” or nearly zero between 2020 and the beginning of this year.

When policymakers were filling the markets with liquidity during the era of easy money, stocks were seen as one of the biggest gainers through a process known as quantitative easing. It is therefore logical that the reverse process – quantitative tightening – and intensifying it could further impact equities.

This month, the Fed’s balance-sheet reduction maximally accelerated to $95 billion in Treasury and mortgage-backed securities, up from $47.5 billion a month earlier. According to BofA’s Cabana, QT’s increasing momentum will put more Treasury and mortgage-backed securities in private hands, create aggressive competition among commercial banks for funding and lead to higher borrowing costs.

Qt’s impact to date “has been minimal,” Cabana wrote in a note on Thursday. Over time, however, this should ultimately result in “higher funding rates, tighter financial conditions, and riskier asset headwinds”.

See: The next financial crisis is already underway – but not where investors might expect

Still, there was a feeling among traders that the Fed’s bullish QT momentum is already making an impact.

“There is a psychological impact of hitting 4% on the 1-year yield — which has the potential to spread to other capital markets overseas,” said Larry Milstein, senior managing director of the government debt business at RW Pressprecht & Co in New York. “People now realize that the Fed is going to have to stay high for a long time, inflation is not going down as expected, and the terminal rate is going up.”

“For a long time, people were talking about TINA, but you don’t necessarily have to be in the equity market to get returns,” Milstein said via phone. TINA is an acronym used by traders for the idea that there is “no option” for a stock.

Like Farwell, Milstein observed that more investors take money out of equities and put it in shorter-term Treasuries.

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