The benchmark 10-year U.S. Treasury yield closed at 2.606%, rising for the fourth consecutive day and hitting its highest closing level since March 2019.

The Federal Reserve accelerated interest rate hikes and balance sheet reduction Under expectations, the performance of U.S. bonds was unsatisfactory.

On Wednesday, U.S. bond yields extended their recent gains. The benchmark 10-year U.S. Treasury yield closed at 2.606%, rising for the fourth consecutive day and hitting its highest closing level since March 2019.

On Wednesday night, the minutes of the Federal Reserve's March meeting and Fed officials hinted that a one-time interest rate hike of 50 basis points may be possible in the future, and revealed for the first time the roadmap for future balance sheet reduction planned by Fed policymakers.

In fact, the day before the meeting minutes were released, U.S. Treasury yields had already moved higher, and then briefly pulled back slightly. After the release of the meeting minutes, U.S. bond yields rose rapidly.

As of press time, the 10-year U.S. bond yield has made a slight correction and is now at 2.590%

Overseas bond markets have been frightened by the Federal Reserve's radical remarks recently.

On Tuesday, the Fed's "second-in-command" nominee Brainard 's remarks about accelerating the balance sheet reduction caused the 10-year U.S. Treasury bond to surge by 16 basis points that day, the largest increase since the outbreak of the epidemic in March 2020.

Brainard said that curbing inflation is the current top priority of the Federal Reserve. He expects to begin rapid balance sheet reduction as early as May, and the pace of balance sheet reduction will be much faster than the 2017-2019 cycle.

This echoes previous statements by Federal Reserve Chairman Powell. It is worth mentioning that Brainard was an outspoken opponent of premature tightening of monetary policy last year.

The path to shrinking the balance sheet is gradually becoming clearer. How will U.S. bond yields go?

Some analysts believe that even if the Fed's balance sheet plan becomes clearer, its potential impact on U.S. debt is far from obvious.

The Federal Reserve's accelerated balance sheet reduction means that demand for U.S. debt will be suppressed. But analysts say the impact on yields is likely to depend both on the amount of future government borrowing and the extent to which the government finances itself through longer-term bonds.

Some analysts believe that the impact of rising short-term interest rates is more direct.

U.S. Treasury yields largely reflect investors’ expectations for the average short-term interest rate over the life of the bond. Due to continued high inflation and aggressive signals from the Federal Reserve, the market expects U.S. bond yields to rise sharply this year.

How high an interest rate can the market bear?

Recently, the U.S. 2-10-year Treasury bond yield curve has inverted, and many analysts believe this is a signal that the United States is about to enter a recession.

Some analysts believe that the recession will not come soon. The purpose of raising interest rates is to cool the economy, which creates the risk of a recession that could lead to a subsequent rate cut by the Fed.

A report released by CICC Research on Wednesday believes that to understand how interest rates affect the market, first of all, short-term expectations are particularly important. When expectations are insufficiently included, it will often lead to severe turbulence in interest rates and markets, regardless of the absolute level of interest rates. Secondly, the speed at which interest rates rise is equally critical, regardless of whether they are high or low. The rapid rise in bond interest rates itself represents an increase in the volatility of bond assets, which can easily lead to the contagion of cross-asset fluctuations. Third, in the long term, when interest rates rise, most stock markets will rise until the mid-to-late period.

But Powell's speech on March 21 and the meeting minutes released on Wednesday hinted that in order to curb inflation, the Fed may take interest rates above 2.4%. This means that the Federal Reserve believes that more aggressive interest rate hikes will not plunge the economy into recession.

CICC found through five analysis methods that the 10-year U.S. bond interest rate of 2.9%~3% may be a more sensitive range, and before reaching this level, the market may still pass risk premium and Profitable cushion to digest.

Method 1: The relative attractiveness of stocks and bonds. The current overall dynamic dividend rate for the S&P 500 is 1.37%. The average value of the S&P 500 dynamic dividend rate vs. the 10-year U.S. bond interest rate from post-2000 to before the epidemic was -1.49%. The current gap between the two is about -1ppt, which means that assuming the dividend rate remains unchanged, when the 10-year U.S. bond interest rate rises to around 2.8~2.9%, the relative price of stocks and bonds will return to near the mean.

Method 2: Long-term correlation between interest rates and valuations and the market. Statistics on the relationship between the S&P 500 valuation and the 10-year U.S. bond interest rate since 1962, we found that the valuation will shrink only after the interest rate reaches a certain "threshold". Since the outbreak, this "threshold" has dropped to 1.6%, explaining The valuation of in U.S. stocks began to shrink since the fourth quarter of last year. But the market "threshold" is higher. Using the same method, the "threshold" that triggers the market turning point has been around 3% since 2013.

Method Three: Equity Risk Premium. Assuming that the equity risk premium shrinks further from the current level to a more optimistic level from 2003 to 2007 (average 2.2%), which corresponds to a contraction of 0.5 percentage points, the 10-year U.S. Treasury interest rate can withstand rising to 2.9%.

Method 4: Interest rates and financial leverage. Comparing the S&P 500 non-financial sector stocks net leverage ratio and the 10-year U.S. bond interest rate since 2000, the two are obviously negatively correlated. Assuming that leverage drops from the current level to the historical average, the corresponding 10-year U.S. bond interest rate is approximately 2.9%.

method five: financing cost and return on investment . When financing costs approach the return on investment, it will erode corporate profits and inhibit investment willingness. We use the S&P 500 index ROIC to measure corporate investment returns, and use U.S. 10-year investment grade (BBB) ​​and high-yield bond rates to measure financing costs. The 10-year high-yield rate (currently 6.1%) is 1.8 percentage points away from the ROIC average. In addition, the current high-yield spread is 23.7%, which is 1.4 percentage points away from the average of 5.1% since 2000. If the 10-year high-yield interest rate rises by 1.8%, the 10-year U.S. bond interest rate will increase by an additional 0.4 percentage points, which corresponds to 2.8%.

Of course, the above-mentioned statically calculated level does not mean that it will not fluctuate before it is reached. Changes in emotions and expectations, as well as the speed of rising interest rates, may still be the reasons for triggering fluctuations.

At present, interest rate derivatives prices show that investors expect interest rates to reach around 2.5% by the end of this year and will quickly exceed 3% next year.

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