Market Extra

‘No magic level’: Yields won’t cool without ‘substantial’ stock selloff, says Barclays

The benchmark 10-year Treasury yield could surpass 5% by next month.

MarketWatch photo illustration/iStockphoto

There’s a debate going on in financial markets over if and when the benchmark 10-year Treasury note yield will get to 5%, with bond traders leaning toward such a scenario unfolding in a matter of weeks.

Data released by Bloomberg on Tuesday shows that traders bought bearish hedges for new risk in rates options over the past week. Most of that action has been in November and December expiries, which have seen open interest jump in Treasury 10-year put strikes. Those positions are hedging a move higher in yields, including the possibility of a 5% yield by November.

Getting to that 5% mark essentially requires more selling by investors of the 10-year government note, at a time when stocks have also lost ground. Dow industrials DJIA have erased their 2023 gains, while the S&P 500’s SPX year-to-date gain has shrunk to 11% as of Wednesday.

Despite Wednesday’s re-emergence of buyers for U.S. government debt, analyst Ajay Rajadhyaksha of Barclays said his firm sees no clear catalyst “to stem the bleeding” from the recent “breathtaking selloff” in longer-term maturities.

“We feel fairly certain about?one point. There is no magic level of yields that, when reached, will automatically draw in enough buyers to spark a sustained bond rally,” he said.

What’s more, Barclays say bonds will not cool off until stock markets see a bigger pullback. “U.S. equities have fallen about?5% over the past three months, as higher yields have finally started to result in multiple compression. But stocks are still up very comfortably for the year. And the magnitude of the bond selloff has been so stunning that stocks are arguably more expensive than a month ago, from a valuation standpoint,” said Rajadhyaksha.

“We believe stocks have substantial room to reprice lower before bonds stabilize,” he added.

Meanwhile, FHN Financial macro strategist Will Compernolle said getting to a 5% 10-year yield is an “easy bar to clear.” The benchmark 10-year rate BX:TMUBMUSD10Y hasn’t closed above that mark since July 17, 2007, and is currently just 26.5 basis points below 5%.

Read: Stock market likely to correct if 10-year Treasury yield reaches 5%, RBC says

The roughly $25 trillion U.S. Treasury market has been caught between two narratives — one based on the need for higher borrowing costs to quell inflation and address a growing government deficit, and the other driven by investors’ growing interest in yields now at their most attractive levels in 16 years. Over the past two weeks, the former case has prevailed, provoking selloffs in the 10-year note and 30-year bond BX:TMUBMUSD30Y, while stoking fears that something is about to break as it did in U.K. markets last year.

See also: Banks are bracing for a recession as Treasury yields surge

On Wednesday, however, buyers re-emerged after a tepid private-sector employment report from ADP for September, sending the 10-year yield briefly below 4.7% from an intraday high of almost 4.9% and the 30-year rate down to as low as 4.85% after a brief spike to 5.01%. This is raising some hopes that buyers can still be enticed by juicy yields.

“What I think we are seeing — whether its 5% on 30-year bonds or a 20-year Treasury yield near 5.2% earlier in the day, or a 10-year rate briefly above 4.8% — is that people are looking at these levels and finally coming out of the weeds to put cash to work,” said William O’Donnell, a U.S. rates strategist at Citigroup in New York.

“They’re seeing levels they couldn’t have imagined in recent years and that’s a positive sign after sellers have completely had their way with bonds,” he said via phone on Wednesday. “It’s a sign to us that these rate levels are finally drawing some interest from investors.”

Yields, with the exception of rates on 1-, 2- and 6-month T-bills, finished lower on Wednesday in reaction to ADP’s report, which showed just 89,000 private-sector jobs were created last month. Meanwhile, U.S. stocks DJIA SPX COMP closed higher, led by a 1.4% advance in the Nasdaq Composite.

The next major U.S. jobs report is due on Friday with the release of nonfarm payrolls data for September, which is expected to show the U.S. added 170,000 jobs, based on economists polled by the Wall Street Journal.

According to Rajadhyaksha of Barclays, however, U.S. economic data is “unlikely to weaken quickly or enough to help bonds, which suggests that risk assets have to keep falling for?longer rates eventually to?find a bid.”