With the yield curve still very inverted, longer-term yields will need to move meaningfully higher to entice buyers away from the attractive short-term rates.
Action to shift to long end of yield curves
As a result of these supply dynamics, much of the action could move to the long end of yield curves, while in 2022 shorter-term yields were more volatile as curves sharply inverted. The two-year U.S. Treasury yield increased 370 basis points (bp) last year, while the 30-year Treasury yield 'only' climbed 207 bp.
German government yields followed a similar course, with the two-year yield rising about 335 bp (from deeply negative territory at the end of 2021) and the 30-year bund yield increasing only 62 bp.4
This should result in a 'twist' in yield curves, with long-end rates most likely increasing and curves steepening. In 2011, the Federal Reserve purposely targeted lower long-term yields in “Operation Twist” by selling short-maturity Treasuries and buying longer-end securities. Today, however, I think that we may be entering a period where central bank actions don’t have much effect on long-term rates because of the distortions caused by the flood of supply.
Ominous potential to crowd out corporates
Most ominously for the economy, a huge boost in high-quality government bond issuance could also crowd out many other borrowers, or at least force up funding rates for corporate borrowers and others that need to refinance.
This would raise the cost of funds for corporations and make them less likely to spend on capital projects or hiring more employees, removing a vital source of support for the global economy just when it needs it most. Also, remember that long-end yields act as the discount rate for many other purposes, so this twist could have far-reaching impacts.
Arif Husain, head of international fixed income, T. Rowe Price
1 Source: Bloomberg consensus projections as of September 5, 2023.
2 Source: International Monetary Fund as of December 31, 2022 (annual data).
3 Source: Morgan Stanley issuance projections as of September 2023. Calculations by T. Rowe Price. Actual future outcomes may differ materially from projections.
4 Source: Bloomberg Finance L.P.
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