January 22, 2021
Markets PAID

Long-Term Bonds Hit Hard After Georgia Senate Runoffs

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Rev. Raphael Warnock beat Sen. Kelly Loeffler in one of the two Georgia Senate runoffs.

Rev. Raphael Warnock beat Sen. Kelly Loeffler in one of the two Georgia Senate runoffs.

Photo: Rich Von Biberstein/Zuma Press

Democratic victories in the Georgia Senate races this week have spurred investors to bet on a higher spending government that will bring growth and inflation to the U.S. economy. That view has shown up most spectacularly in the sharp rise in Treasury yields, especially among longer-dated bonds.

The 30-year Treasury yield has jumped by more than one-fifth of 1 percentage point since the start of the year to hit 1.855% early Friday morning, according to
Tradeweb.
That is the highest yield since late February apart from one day in mid-March last year, when Treasury markets were gripped by the dash for cash at the onset of the Covid crisis.

The 10-year Treasury yield has also risen, breaching the 1% level for the first time also since the market dysfunction in March.

“Inflation expectations have been going up significantly just this week,” said William Dinning, chief investment officer of Waverton Investment Management, the U.K.-based fund manager formerly known as J.O. Hambro. “There is upward pressure” for Treasury yields to rise, he said, “but we know that the Federal Reserve is going to be out there buying the debt to keep a cap on yields,” he added.

When bond yields rise, prices fall and that means investors who own these bonds lose money, on paper at least. The sharp rise in Treasury yields has meant a poor return on the assets. The Bloomberg Barclays U.S. Treasury Bellwethers index shows 30-year bonds have returned minus 4.6% so far this year, according to FactSet. The returns on 10-year bonds is minus 1.5%.

Mr. Dinning said there is still a strong attraction to owning long-term bonds. “We recommend people own 30-year U.S. Treasurys because they have been consistently negatively correlated with stocks, so are a good hedge.” 

The 30-year Treasury has acted as a better hedge against stock market ups and downs than shorter-term bonds, where the relationship broke down for much of last year. A balanced stock and bond portfolio that aims to take advantage of the negative correlation between the two assets has long been a key strategy for investors.

Democratic candidate Raphael Warnock is set to be the first Black American to represent Georgia in the Senate, as the AP declared him the winner of a close runoff election over Republican Sen. Kelly Loeffler. Which party will control the chamber is still to be determined. Photo: Raphael Warnock/YouTube

The Wall Street Journal Interactive Edition

Long-term bond prices slid as U.S. stock markets rallied in spite of the scenes of chaos when a mob of Trump supporters stormed the Capitol this week.

Investors are betting that growth and inflation will rebound. Democratic majorities in both the Congress and Senate—even if they are slim—are expected to boost public spending to drive an economic recovery.

The rise in inflation expectations can be seen in the difference between yields on ordinary Treasurys— known as nominal yields—and those on inflation-protected Treasurys, known as real yields. That difference is called a break-even rate.

The 10-year break-even rate rose above 2% this week for the first time since 2018. The 30-year break-even rate also rose above 2% this week for the first time since April 2019.

Despite this, the Federal Reserve isn’t expected to lift interest rates for years, but will keep stimulating the economy by buying Treasurys and other bonds. The Fed wants to let the economy run hot with inflation above target for a while to balance out the long period of below-target inflation of recent years.

The longer-term effects of Covid-19 on the economy and consumer behavior has left some people skeptical that inflation will rise sustainably. Further waves of the virus will engender a stop-start economy potentially for years to come, according to Helen Thomas, chief executive of Blonde Money, a boutique research firm.

“Inflation is going to be all over the place,” she said. “It will be so spiky it will be almost useless.”

Write to Paul J. Davies at paul.davies@wsj.com