The worst of the bond rout is yet to come, says Piper Jaffray

Investing


It all started with bond yields.

Spiking yields spilled over onto the stock market in the past week, first triggering a nearly 666-point drop on the Dow last Friday and then sparking two declines of more than 1,000 points within just 4 days.

The bond rout will continue with yields on the 10-year possibly reaching 3 percent in the near term, according to Craig Johnson, senior technical strategist at Piper Jaffray. That is a level it has not reached since January 2014.

“This is a 36-year reversal in rates,” Johnson told CNBC’s “Trading Nation” on Thursday. Bond yields, which move inversely to prices, have generally been in decline over the past 3 decades, indicating a long-term bull market for bond prices.

“When you reverse that downtrend from down to up you typically get a momentum response and a quick move up. That’s exactly what you’re seeing in the bond market right now,” added Johnson. “You’ve got to be careful in here right now.”

The yield on 10-year Treasurys has risen at a fast clip since the U.S. election in November 2016. Bond yields held at around 1.8 percent prior to the election and have since moved up 100 basis points to hit a 4-year high of 2.86 percent this week.

The uncertainty of a Trump presidency initially sent bond prices lower and yields higher at the end of 2016. Now, worries over the effect an accelerating economy and rising inflation might have on Federal Reserve policy this year have taken over. Historically, bond prices fall when interest rates rise.

“A lot of what pushed this initially was inflation. Inflation fears, inflation concerns,” said Gina Sanchez, CEO of Chantico Global.

Average hourly earnings in December rose at their fastest pace since 2009, increasing expectations that the central bank might need to raise the federal funds rate faster than it had planned to prevent inflation from overheating. Add the possible benefits of the tax reform package to the mix, and the Fed could need to raise rates as many as four times this year. The first rate increase of the year is expected at the March meeting, according to CME Group.

Sanchez does not see overinflation as a major concern to the economy at the moment. Wage growth has returned, but just barely, she said. The ballooning U.S. deficit is more troubling, especially after the House and Senate passed a spending bill that dramatically increases U.S. debt.

“That is probably a bad idea at this point in the cycle,” said Sanchez. “It puts the U.S. in a more unsustainable position.”

Congress passed a budget deal early Friday that will fund the federal government through March 23, allowing the House and Senate more time to craft a full-year budget. The legislation also extends the authority to borrow through March 2019 which takes the threat of a shutdown off the table for the rest of the year.

Fiscal conservatives balked at the bill’s cost. The legislation would increase the U.S. deficit by around $320 billion, pushing the annual deficit to $1 trillion, according to the Congressional Budget Office. The substantial increase could put pressure on the government-backed fixed-income market.

The yield on U.S. 10-year Treasury bonds traded at 2.84 percent on Friday morning. The 30-year Treasury yield was largely flat at 3.14 percent.



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