And though the 10-year yield recovered somewhat Thursday as Treasury prices dropped, Wednesday’s dip below 2% came as a surprise. Many investors, me included, had been expecting a more consistently slow and steady rise in yields, as the U.S. economy continues to recover and the Federal Reserve (or Fed)’s rate normalization nears.
Market Realist – The graph above shows the movements of the yield curve in October. The bond market exhibited a lot of noise and turbulence in the week ended October 17, 2014. U.S. ten-year Treasuries even fell below the 2% mark briefly on Wednesday, October 15, 2014.
Short-term Treasuries with maturities of three years (SHY) declined from 1.05% on October 3, 2014, to 0.73% on October 15, 2014. Ten-year Treasuries (IEF) fell sharply, from 2.45% on October 3, 2014, to 2.15% on October 15, 2014. Thirty-year Treasury yields (TLT) also fell, from 3.13% to 2.92%, during the period.
Instruments across the fixed investment spectrum suffered. High yield bond funds (HYG)(JNK) saw outflows of $549 million in the week, as per estimates from Lipper. Emerging market bonds (EMB) fell too as investors eschewed high-risk assets. Declining oil prices pressured Venezuela and Russia’s markets.
The steep fall in yields comes as a surprise. The Federal Reserve is likely to conclude its bond buying (TLT) program this month. The federal funds rate is expected to rise from its currently low levels of 0%–0.25% as the Fed begins its rate normalization policy next year. The coming rising rate environment would usually suggest a rise in bond yields. A rise in rates means a fall in bond prices. The higher the maturity, the steeper the fall in price. Amid expectations of rising rates, we can anticipate a fall in yields and an increase in prices.
Read on to the next part of this series to learn the reasons behind the surprise fall in yields.