The longest rise in yields in the US since the 1980s is based not only on economic forces but also on ‘forced’ sellers. Who are the players who may need to liquidate positions in the bond market other than for economic reasons?
1. Central banks
The foreign exchange balances held by the world’s central banks are decreasing rapidly. The decrease is due to the decrease in the value of the assets in which the balances are invested and the appreciation of the non-dollar balances to the US dollar. Apart from this, there are reports that some central banks are selling foreign exchange to curb the weakening of the local currency. Japan officially did so and apparently repeated the intervention last Friday, which led to a roughly 1.5% appreciation of the yen. There are reports that the Chinese are selling foreign currency and so are the other central banks. As evidence, the American bond balances in their custodial accounts at the Fed have decreased sharply since the beginning of 2021, when at the end of August the decrease was particularly sharp.
2. The Japanese
Japan, the largest foreign holder of US debt, is raising major concerns about the possibility of selling bonds. Inflation in Japan continues to rise, including core inflation that reached 1.8%. The central bank continues to stick to fixing the 10-year yield below 0.25%. However, The 30-year yield is rising rapidly and has already reached 1.6%.The gap between 30 and 10 years in Japan is the highest in the world.
The central bank may cancel the fixation to deal with inflation and even raise interest rates at the same time. A move of this type will sharply increase the entire yield curve, strengthening the yen, the currency that is used as a carry currency. Rising yields in Japan may lead to the return of Japanese investors to the local bond market at the expense of their very large holdings abroad.
3. Private investors outside the US
For private investors from abroad, the viability of investing in American bonds has greatly decreased as a result of rising yields also in the local markets and a sharp increase in currency hedging costs. Excess yield on the US 10-year currency-protected bond compared to local currency bonds for investors from Japan and Europe fell to the lowest negative level since 2008 (Chart 11).
4. The commercial banks
The commercial banks turned from significant buyers of government bonds during the Corona period to sellers (Chart 12). Bank sales are related, among other things, to the reduction of the FED’s balance sheet and the decrease in the banks’ reserve balances.
5. Sales of leveraged investors
The last force that should be feared is the possible effect of a rapid rise in yields on leveraged investors who could be the hedge funds or the pension bodies, as was the case recently in England. These investors may need to sell in the hula forced upon them. We have no evidence that there are indeed significant sales of this type, but the speed of increase in yields and recent intraday volatility could be a sign of such a possibility.
Who is buying anyway and where are the returns headed?
Who can stand against the flow of sellers? Apparently, the institutional investors are standing against the many sellers and buying bonds. In the weekly JP Morgan survey regarding the position of their institutional clients who invest in the bond market, the proportion of investors who reported a long position rose to one of the highest levels in the last two years. Institutional investors’ long bond futures position rose to the highest level since 2018.
Even statistically the longest and highest streak of rising yields since the early 1980s has a high chance of ending. Assuming that this is not an event that indicates a deterioration in financial stability, the recent rise in yields reflects a buying opportunity in our estimation. Evidence is mounting that the US economy is slowing, while reducing inflationary pressures. From the publication of the FED’s “Beige Book” last week, it was possible to learn that growth in the economy is moderating. In various regions of the US, signs of cooling in the labor market and an easing of pressures for price increases are beginning to be detected. If and when the economic data begin to indicate these processes more clearly, the direction of yields is expected to quickly reverse from an increase to a decrease. Bottom line: We recommend increasing the weight of bonds in portfolios and Medium-long term holding.
**The author is the Chief Economist of the Meitav Investment House**