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Bond Rout: Reasons behind the Yield Surge since April

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Looking forward, even if you assume bond yields settle down, probably somewhere in last fall’s range of 2.2% to 2.6% for the 10-year Treasury note, this moderate year-to-date rise is still likely to inflict significant damage on parts of the market.

As I write in my new weekly commentary, “Staying Grounded as Rates Drift Higher,” parts of the market sensitive to rate increases have proved to be vulnerable. As such, investors may want to consider two less obvious places to ride out the rate regime change: financial and health care stocks.

reasons behind the yield surge

Market Realist – Yields continue to surprise to the upside despite sluggish growth dragging down the global economy. The International Monetary Fund (or IMF) recently cut its forecast for global growth for 2015 to 2.8% from the 3% it predicted in January.

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The IMF also downgraded the outlook for developing or emerging markets (EEM) in 2015 and 2016. It forecast growth for developing economies at 4.4% and 5.2% in 2015 and 2016, respectively. This is lower than its January forecasts of 4.8% and 5.3%, respectively. IMF attributes the downgrade in developing economies to weaker exchange rates and lower prices of oil (USO) (BNO).

The above graph shows the current GDP (gross domestic product) growth prevalent in the world.

reasons behind the yield surge

One of the primary reasons behind the yield surge is positive US economic data that are increasing anxiety about a Fed rate hike. The labor economy seems to have regained its stride after faltering in March. The US economy added a decent 280,000 jobs to its non-farm payrolls in May 2015. The unemployment rate continues to stay low at 5.5%. Wages are showing signs of a breakout with average hourly earnings rising by $0.08 in May, taking the year-over-year wage growth to 2.3%.

The labor force participation rate has ticked up by 0.1% to 62.9%. According to reports from the BLS (Bureau of Labor Statistics), the number of discouraged workers, or those out of the workforce for more than 27 weeks, was the lowest in almost six years. This is a heartening sign, indeed.

Manufacturing also continues to be in an expansion mode. The ISM (Institute for Supply Management) Manufacturing Purchasing Managers Index exceeded analyst expectations by increasing to 52.8 in May after staying constant at 51.5 in March and April.

Equity (SPY) (IVV) and bond markets (TLT) have taken these positive economic indicators to mean an increase in the likelihood of a rate hike in September. Investors are not waiting for the Fed to hike rates. They’re fleeing bond markets before policy normalization even begins.

The other factor seems to be investors unwinding positions in European bonds as sentiment continues to be buoyed by signs of an economic resurgence in the Eurozone (EZU).

Read on to the next part of this series to understand how a taper tantrum may again be in the cards as fears of a rate hike spike.

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