Stock Market

Here’s why markets believe a breakthrough of the U.S. 10-year yield past 1% is in sight

After months of waiting for the 10-year Treasury yield to break above the 1% level, market participants now say the runoff elections for the U.S> Senate on Tuesday could offer the decisive impetus for a breakthrough.

The distribution of COVID-19 vaccines and accompanying hopes of a return to economic normality so far have not done much to lift Treasury yields, as bond buying by the Federal Reserve has been more than able to offset any bearish pressure associated with recovering economic growth and rising inflation expectations.

But analysts say the chance for a more aggressive fiscal policy under a Democratic-controlled Senate, based on the possible outcome of Tuesday’s vote, could send long-term bond yields higher.

That’s a growing possibility, with polls showing Democratic candidates, Jon Ossoff and Rev. Raphael Warnock, in a tight race with their Republican incumbents.

“Nominal yields on the other hand have flatlined since early December, in a sign that investors believe that the Fed will continue to suppress yields even as inflation expectations normalise,” said Padhraic Garvey, regional head of research for ING in the Americas. “Additional fiscal thrust to the economy could change that dynamic however.”

See: Here’s why the Georgia runoff elections for the U.S. Senate could turn into a ‘big deal’ for markets

The 10-year Treasury note yield

was at 0.94% on Tuesday, a few basis points away from its December high of 0.986%. A push beyond that milestone would set the benchmark note yield on track towards the 1% level that has contained the maturity since March.

Even as yield have remain capped, inflation expectations, as measured by inflation breakeven levels, have steadily climbed, pushing through the key 2% threshold for the first time since November 2018.

Analysts say the divergence between rising inflation forecasts and the muddled trading in government bonds has been underpinned by the possibility the Fed could still tweak its asset purchases to keep longer-dated rates anchored.

It’s why Ian Lyngen of BMO Capital Markets estimates a Democratic victory over both Senate seats may not do much to benefit the bond bears, only pushing the 10-year yield up by around 10 to 15 basis points.

That would be enough to push the benchmark rate above 1% but not enough to spark the full-blown bond-market selloff that many feared could occur in 2021.

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