The Debate Over the 10-Year Treasury Yield

The financial markets are currently engaged in a debate about whether or not the benchmark 10-year Treasury note yield will reach 5%. Bond traders, in particular, believe that this scenario could unfold within a matter of weeks.

Recent data released by Bloomberg indicates that traders have been purchasing bearish hedges for new risk in rates options. Most of this activity has been focused on the November and December expiries, which have experienced a significant increase in open interest for Treasury 10-year put strikes. These positions are intended to hedge against a potential rise in yields, including the possibility of a 5% yield by November.

Achieving this 5% mark would require more selling of the 10-year government note by investors, which is occurring at a time when stocks are also experiencing losses. The Dow industrials have already erased their gains for 2023 as yields continue to climb, while the S&P 500 has seen its year-to-date gain shrink to around 12% as of Wednesday afternoon.

Despite a recent resurgence of buyers for U.S. government debt on Wednesday, analysts from Barclays and FHN Financial remain skeptical. Ajay Rajadhyaksha from Barclays believes there is no clear catalyst to stop the recent selloff in longer-term maturities, referring to it as a "breathtaking selloff." On the other hand, Will Compernolle from FHN Financial argues that reaching a 5% 10-year yield is an "easy bar to clear." It's worth noting that the benchmark 10-year rate hasn't closed above this mark since July 17, 2007, and is currently only 25 basis points below it.

The $25 trillion U.S. Treasury market finds itself stuck between two competing narratives. One suggests that higher long-term borrowing costs are necessary to combat inflation, while the other is driven by investors' increasing interest in yields, which are currently at their most attractive levels in 16 years. In the past couple of weeks, the former narrative has prevailed, resulting in selloffs in the 10-year note and 30-year bond. This has also led to concerns that a similar situation to last year's market turbulence in the U.K. is about to unfold.

Banks Brace for Recession as Treasury Yields Surge

Buyers have re-emerged in the market after a tepid private-sector employment report from ADP for September. This caused the 10-year yield to briefly dip below 4.7% from its intraday high of almost 4.9%, while the 30-year rate settled around 4.87% after a brief increase to 5.01%. These movements have raised hopes that buyers can still be enticed by attractive yields.

According to William O’Donnell, a U.S. rates strategist at Citigroup, investors are taking notice of these levels and are finally putting their money to work. The high yields on 30-year bonds and a 20-year Treasury yield near 5.2% are drawing interest from investors who were previously deterred by lower rates.

In response to the ADP report, rates on various Treasury bonds, ranging from 1-month T-bills to the 30-year bond, were mostly lower on Wednesday afternoon. The report showed that only 89,000 private jobs were created in September. At the same time, U.S. stocks were experiencing mixed performance.

The next major U.S. jobs report is set to be released on Friday, which will provide nonfarm payrolls data for September. Economists polled by The Wall Street Journal expect the report to show that the U.S. added 170,000 jobs. However, according to Rajadhyaksha of Barclays, U.S. economic data is unlikely to weaken quickly enough to help bonds. This suggests that risk assets will need to keep falling for longer rates to eventually find a bid.