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Since the beginning of the year, this corresponds to an increase in returns of around 0.2 percentage points and a price loss of around two percent. That doesn’t sound like a lot, but it’s a significant move in such a short time for US Treasuries.

Carsten Klude, chief investment strategist at the private bank MM Warburg, states: “Instead of an escape to safety, we see an escape from safety.” This is all the more astonishing because the environment with the unrest in the USA and corona infections continue to rise Investors should actually have to invest their money in bonds in which they can at least assume a repayment of the capital.

Due to the economic strength of the USA, the dominance of the dollar and also the political stability, US government bonds in particular are considered safe investment havens in uncertain times. Despite the uproar instigated by supporters of outgoing US President Donald Trump, the reputation of American government bonds has not suffered.

Fear of rising inflation

Andy Cossor, bond analyst at DZ Bank, says: “Investors are obviously assuming that the US will get the unrest under control and that Biden will again unite US citizens more strongly.” Cossor reads this from the fact that the returns are also of other bonds that are considered safe, such as German Bunds, have risen – albeit not as significantly as those in the USA.

But the development has nothing to do with political stability, but with the economy. Specifically, investors in the bond market fear that the designated US President Biden will significantly increase government spending in order to stimulate the economy. “That would raise inflation significantly,” says Cossor. Experts call this connection reflation.

For Klude von MM Warburg, too, the increased inflation expectations are the main reason for the rise in bond yields. Inflation is poison for bonds because it eats away at the already meager interest income.

Investors also worry that if the economy improves, the Federal Reserve could tighten monetary policy by buying fewer US Treasuries. This phenomenon, known as tapering, would push US yields even higher.

More government spending means more debt

US yields have been increasing more strongly since the end of October. At that time it became clear that the Democratic presidential candidate Biden had a good chance of winning the race for the White House. Since then, returns over a ten-year period have risen by 0.4 percentage points.

Investors sold more bonds early last week, and yields got another boost accordingly. The trigger is that the Democrats won the runoff election for two senatorial posts in the US state of Georgia. This means that Biden’s party now has a majority not only in the House of Representatives, but also in the Senate and thus in the entire Congress.

That means: Biden can implement his plans more easily – and actually put together larger fiscal packages. This means that US debt will continue to rise.

The US Congress had already passed a new corona aid package worth 900 billion dollars at the turn of the year. It is already clear that this package will not be enough to sustainably support the US economy. Biden can now get more help with the help of Congress. The US bank Goldman Sachs estimates that the aid package will be increased by $ 750 billion in February or March.

Biden has also already announced that it will increase direct financial aid for US citizens from the current $ 600 to $ 2,000 per family. His election manifesto envisages spending of four trillion dollars by 2024, two trillion of which will be invested to curb climate change and make infrastructure greener.

Fear of reflation

All this has increased the fear of reflation. Economists pay particular attention to the “five-year-five-year-forward” inflation barometer derived from the futures markets. It has risen to more than 2.3 percent, the highest level since December 2018. That means: Investors see inflation in the five-year period from 2026 at around 2.3 percent. Most recently, the inflation rate in the USA was 1.4 percent.

That is exactly what weighs on the bonds. This is not only evident in the case of papers with a ten-year term. The yield on 30-year bonds approached the two percent mark for the first time since February last year.

Only papers with a term of two years are relatively stable at less than 0.15 percent. This in turn means: the so-called yield curve – the yield gap between short-term and long-term bonds – is steeper than it has been in three years. This is also a sign of higher inflation expectations combined with a recovering economy.

The stock markets ignored the rise in yields for a long time, the Dow Jones Index, the S&P 500 and the index of the technology exchange Nasdaq reached record levels last week. “The stock markets have ticked Corona and are playing with the vaccinations against the virus that have been started on an economic recovery,” says Klude from MM Warburg.

However, there are signs that the good mood in the equity markets is crumbling as the flight from safe bonds unsettles investors in the equity markets. The US stock indices fell significantly at the beginning of the week on Monday, especially in the technology sector, and have not been able to match their recent record highs since then. The strategists at Commerzbank justify this with the “fear of the sell-off of US government bonds”.

Several US central bankers have intensified these fears. Raphael Bostic, a voting member of the US Federal Reserve (Fed), said that he can imagine the US Federal Reserve scaling back its bond purchases later this year. Fed members Robert Kaplan, Patrick Harker and Chales stressed that the Fed should discuss when to reduce bond purchases. Investors are therefore excited about a speech that US Federal Reserve Chairman Jerome Powell will give in a webinar at Princeton University this Thursday.

The Fed has expanded its bond purchases massively over the past year, buying US Treasuries for $ 80 billion and mortgage-backed structured bonds for $ 40 billion every month. In doing so, it supports the market considerably. Without the Fed purchases, US Treasury bond yields would be much higher.

Threat to equities and emerging markets

A sharp rise in inflation and bond yields is a horror for many markets. Examples from the past show this. The most recent share crash due to fears of rising interest rates occurred in early February 2018.

At that time, the Dow Jones index lost 4.6 percent within a day. Previously, ten-year US Treasury yields had risen by more than half a percentage point to a four-year high of almost three percent in just a few weeks. At that time, too, the trigger was higher inflation expectations. They raised fears among investors that the US Federal Reserve would raise interest rates even further.

After all, investors do not yet need to have fears of interest rate hikes. At the end of August, the Fed announced a change in strategy and stated that inflation could remain above its previously favored level of two percent for a longer period of time before raising interest rates.

Burden on business

Since then, however, with the hope of an economic recovery after the Corona slump, inflation expectations in the markets have risen more strongly. Correspondingly, the yield on ten-year US Treasuries has more than doubled since its record low of just half a percent in August last year.

However, not only higher central bank interest rates, but also government bond yields mean that companies have to pay more for their debts. After all, corporate bond yields move more or less in line with government bond yields. However, higher refinancing costs eat into the company’s profits and therefore also put a strain on the shares.

Higher yields on US government bonds also often lead to a strengthening of the dollar because more money then flows into the US. This, in turn, is putting a strain on the emerging markets, which are at least partly in debt in dollars. With a higher dollar, the foreign debt of emerging countries increases. In addition, investors often shift their money from the riskier emerging markets when they get more attractive returns on US Treasuries.

Mohammed El Erian sees a “challenge” for investors

Investors should not ignore these risks, especially since the US stock markets are already valued very highly. A key reason investors tolerate the higher valuations is that, despite the recent surge, bond yields are still low.

According to the financial information service Bloomberg, analysts expect an average ten-year US return of 1.25 percent by the end of the year. This means that bond prices are likely to fall a little further. Institutional investors cannot do without bonds in their large portfolios, but they can expect further price losses.

In addition, there is no alternative to stocks in the environment of low yields. Investors who still want a chance for returns cannot avoid stocks. In addition, investors are betting that life will normalize again this year and that the economy will recover. The massive aid programs of the states and central banks, which exist not only in the USA, but worldwide, help.

In the opinion of Mohammed El Erian, Allianz’s chief economic advisor and ex-head of the world’s largest bond investor Pimco, these are understandable reasons for the expectation of further increases in the stock markets.

But investors shouldn’t be too careless and watch the bond market closely. If the trend towards rising yields and a steeper yield curve continues, this will be “a challenge” for monetary policy as well as for investors, according to El Erian.

More: The stock exchange ignores the corona pandemic and the lockdown, prices rise and rise. A look at the key figures reveals the first alarm signals.