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Why Are Bond Yields Rising?

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Why Are Bond Yields Rising?

Written by: Alex Dryden

With the U.S. 10-year yield pushing past 3% and reaching its highest level since January 2014 investors are wondering why are yields rising now? As we highlight in the below chart for the last few years two anchors have been weighing down on the back-end of the yield curve: demand from international investors for U.S. fixed income and a lack of inflationary pressure. In 2018 both of these anchors have begun to lighten.

For the past few years, U.S. yields have looked attractive to overseas buyers. However, in 2018 the cost to international investors of hedging U.S. dollar currency exposure has increased dramatically. For example, at the start of 2017, a European investor could hedge their U.S. dollar exposure for 12-months for 1.3% however, in 2018 this cost has more than doubled to 2.7%. Rising hedging costs have eroded the relative attractiveness of U.S. fixed income to overseas investors. Falling demand from overseas has pushed U.S. bond prices down and forced yields higher.

The lack of overseas demand has coincided with rising inflationary pressure domestically. We see inflationary pressure coming from three places: wage growth, the falling dollar and rising oil prices. The tightness in the labor market has started to give rise to earnings growth with average hourly earnings in March hitting 2.7%. Wages should continue to rise as the labor market tightens further. Inflationary pressure is driven higher by the falling U.S. dollar, which increases to the price of imports into the U.S. and oil prices moving higher. With inflation now back on investor’s radar, bond yields have begun to grind higher.

Related: Factor Crowding, Timing and the Future of Factor Investing

The takeaway for investors is that higher bond yields are likely here to stay as both anchors continue to lighten in 2018. We encourage investors to remain flexible when managing duration, sectors and geographies during this tough time for fixed income markets.

Targeting lower duration amid today’s higher rates? Explore JPST

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