U.S. Treasury bond yields jumped higher Friday, extending one of the biggest fixed income market declines in seven decades, as investors grapple with the twin concerns of surging inflation and debt-fueled attempts to revive economic growth.
Benchmark 2-year Treasury note yields, which were trading as low as 26 basis points in September of last year, were pegged at 4.195% -- the highest since late 2007 -- in early New York dealing Friday as traders re-set Federal Reserve rate hike bets following a series of hawkish comments from Chairman Jerome Powell earlier this week.
That puts the yield gap over 10-year Treasury notes, which were last seen at 3.754%, at around 44 basis points, a deeper "inversion" of the yield curve that often signals recession.
According to a study from the San Francisco Federal Reserve, a sustained inverted yield curve has preceded all of the nine recessions the U.S. economy has suffered since 1955, making it an extremely accurate barometer of financial markets sentiment.
U.S. Treasury bond yields, in fact, have risen more than 110 basis points since August 1, Bank of America noted in its weekly 'Flow Show' report Friday, helping put global bond markets on pace for their biggest annual declines in more than seven decades.
What BofA calls a 'bond crash' could "threaten credit events and liquidation of world's most crowded trades: long U.S. dollar, long U.S. tech and long private equity."
"True capitulation is when investors sell what they love & own," BofA said.
The Fed's seemingly singular hope of a avoiding a so-called "hard landing" from its inflation fight -- a resilient job market -- is also starting to wobble. Weekly unemployment claims have missed analysts' forecasts nine consecutive weeks, and rose to 213,000 for the period ending on September 17.
The Fed itself sees unemployment rising to 4.4% by the end of next year, a move it hopes may moderate wage growth and prevent inflation from becoming more deeply imbedded in the U.S. economy.
Fixed income traders are also betting on another 75 basis point rate hike from Fed in November, according to the CME Group's FedWatch, while the Atlanta Fed's GDPNow forecasting tool suggests third quarter growth has slowed to just 0.3%.
"It’s possible that the unemployment rate could gently glide higher and wages cool without an outright recession—but it’s never happened before," said Bill Adams, chief economist for Comerica Bank in Dallas.
"Historically, increases in the unemployment rate of the size that the Fed wants to see have coincided with a recession, meaning notable declines in employment, income, output and sales, spread widely across the economy and probably lasting for more than a few months," he added.
Elsewhere, bond markets are reacting to both slowing economic activity data, which are signaling near-term recession in Europe and the U.K., as well as the new British government's focus on tax cuts and extra borrowing to cushion the impact of its cost-of-living crisis.
PMI readings from Europe, which gauge the sentiment of business leaders and operational managers around the region, have fallen below the 50 point mark for three consecutive months, including September, suggesting the world's biggest economic bloc is likely already in recession.
"The third quarter clearly marks a turning point for the eurozone economy," said ING's senior economist Bert Colijn. "After a strong rebound from contractions caused by the pandemic, the economy is now becoming more severely affected by high inflation both at the consumer and producer level."
"The manufacturing sector is bearing the brunt of the problems," he added. "Supply chain problems still disturb production, but weaker global demand has caused backlogs of work to fall as new orders are decreasing quickly."
In Britain, finance minister Kwasi Kwarteng, in his first budget statement under new Prime Minister Liz Truss, unveiled plans to borrow an extra $80 billion in order to pay for both the reduced tax levies and a planned cap on energy costs for domestic consumers.
Benchmark 5-year Government Gilts, the equivalent of a Treasury bond, suffered their biggest single-day decline since 1991 while the pound slumped to a fresh 37-year low of 1.1160 against the dollar.
"The sell-off in UK assets reflects the sheer panic as the new government’s stimulus package will not only grow an already sizeable debt burden, potentially to unmanageable levels but will also add to inflationary pressures," said Fiona Cincotta, senior financial markets analyst at London-based City Index.
"The Bank of England, which has been reluctant to hike rates aggressively, will need to roll up its sleeves and fight inflation with larger rate hikes," she added. "Expectations for a 1% hike in November are already climbing."
