U.S. Treasury Bond Yield Is Going Up
Donald Trump, North Korea, and the Germans may have given the markets a shake. Wall Street, and all other major global stock markets, are facing their biggest test of 2017. After setting a series of impressive (and unlikely) records, the Dow Jones has stalled its race toward the next landmark high.
The German elections have delivered mixed results, which—along with the ongoing U.S.-North Korea conflict—has left investors worried.
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In times of risk, U.S. treasury bond yields tend to rise. Like German bonds (or gold, the Japanese yen, or even the Swiss franc), U.S. treasury bonds have the characteristic of being a top safe-haven investment when tensions—economic, political, or otherwise—shake the market. Those who imagined that Trump’s first year in office would be good for Treasury bond yields were on the right track.
The problem is that investors in 2017 appear to have become complacent when it comes to risk. No matter what’s thrown at them, they eat it all up. But the day of risk indigestion is coming.
Historical U.S. treasury rates are also higher when interest rates are higher. Thus, in the late 1990s and just before the 2008 stock market crash, treasury bond yields were around five to 10 percent. That’s more than twice the present yield. Back then, interest rates were the key driver.
U.S. Treasury Yields Fall? Not Anytime Soon
But, now, in the interest-rate limbo that the Federal Reserve has created for us, bond yields have become more reliant on external threats. Geopolitical risks have given new life to U.S. treasury bills. Trump’s election did, in fact, push yields to their highest level since 2014—from about 0.5 percent to a high of 2.6 percent in March. Yields dropped gradually to just under 2.1 percent in early September, but now they’ve started to climb sharply again.
Chart courtesy of StockCharts.com
The triggers for the rising treasury bond yields are coming from many directions. That’s because risks are rising, and few leaders have any clear ideas about how to manage them.
The German elections appear to have been the trigger for a sustained yield rally, and there’s plenty more fuel to keep the fire burning.
Indeed, Chancellor Angela Merkel’s center-right Christian-Democrats did win the highest number of votes, as expected. But they did not win a majority. They got the lowest share of votes since World War II, i.e. the lowest vote share since a fellow called Adolf Hitler was in Berlin. The far-right Alternative fur Deutschland (AFD) was the third-best contender. In Germany, the idea that a far-right party could upset an election result produces gloom—and expectations of doom.
The market fears a rise of extremist parties in Europe. But, even more, it fears the heightened tensions between the U.S. and North Korea. Each country has been raising the verbal stakes in a “he did it” kind of game, reminiscent of pre-school siblings. North Korea says the U.S. declared war on them, while Trump calls North Korea’s leader “Rocketman.”
The North Korean air force has been flexing its muscles. It has warned that any U.S. plane will be shot down if its pilot attempts to enter North Korea’s airspace.
North Korea has claimed that it has developed a miniature nuclear warhead, ready to be deployed on its ballistic missiles. Trump has threatened to hit North Korea with the kind of “fire and fury the world has never seen before.” North Korean leader Kim Jong-un responded by announcing that he wants to launch a mid-range missile against a base on the island of Guam, which is an American territory in the Pacific, just 3,400 km from Pyongyang, North Korea.
Increased demand for U.S. government bonds has also resulted from the Federal Reserve’s recent—and confusing—announcements. After deciphering the cryptic language that Fed Chair Janet Yellen has used about the extent of the interest rate hikes, it seems that rates will definitely rise for a third time in 2017.
If that weren’t sufficient fodder, the potential clash between Trump and U.S. Congress over his ambitious tax plan could end as badly as the effort to scrap Obamacare.
You might feel a little more threatened now, but at least you know that treasury yields will be rising.
