A wild run for global government bonds took an unexpected turn on Wednesday after the Bank of England stepped in to stop a rout in the U.K. gilts market, spurring a furious rally on both sides of the Atlantic.

The sharp move added to a stretch of highly volatile trading sessions and came just after the 10-year U.S. Treasury note had climbed above 4% for the first time in more than a decade—a significant milestone that was quickly swept away by the day’s events.

Yields on government bonds, which rise when their prices fall, have been climbing all year as central banks around the world try to combat the worst inflation in decades by raising short-term interest rates and otherwise tightening monetary policies.

In the past week, however, yields rose at an especially alarming rate. Investors began dumping bonds last Thursday, a day after the Federal Reserve had signaled that it would likely lift rates even faster than investors had expected. They got another jolt on Friday when the new U.K. government announced that it would cut taxes and greatly increase borrowing, setting off disorderly selling in U.K. bonds that spilled across borders.

Those moves, however, reversed overnight when the BOE released a statement saying it would “carry out temporary purchases” of longer-term U.K. bonds “to restore orderly market conditions.” The central bank also delayed plans to sell U.K. bonds that it had accumulated earlier in the pandemic.

U.K. bonds led Wednesday’s rally. But there were also large declines in U.S. Treasury yields, reflecting what investors and analysts described as relief on Wall Street that at least one cause of recent selling was being addressed.

In the current environment, “anybody with a forceful move that supports financial price stability helps all markets to some extent,” said Jim Vogel, interest-rates strategist at FHN Financial.

The benchmark 10-year U.S. Treasury yield settled at 3.707%, according to Tradeweb. That was down from as high as 4.017% in the overnight session and its Tuesday close of 3.963%, marking its largest one-day decline since March 2009.

The 10-year U.K. bond yield fell to around 4.05% from roughly 4.50% before the Bank of England’s announcement.

In recent months, rising Treasury yields have ratcheted up borrowing costs for households, businesses and the government and have slammed the stock market, slashing corporate valuations and sending the Dow Jones industrials into a bear market this week. New stock offerings have ground to a standstill, highly indebted companies are facing a tough fundraising landscape and mortgage costs have jumped, causing a slowdown in the housing market.

Through Tuesday, the 10-year U.S. yield had climbed nearly 2.5 percentage points this year, the largest increase over that period since 1981.

Other assets got a boost from the drop in bond yields on Wednesday, as the prices of both stocks and commodities climbed.

It remained far from clear whether the rally in bonds was sustainable. In recent days, analysts on Wall Street have sometimes struggled to understand exactly why yields were rising so much, and the same was true for their reversal on Wednesday.

Among the eye-catching developments: While yield declines in the U.K. were led by longer-term bonds, in the U.S. market they were just as large among shorter-term Treasurys, the yields of which are typically dictated by the near-term outlook for interest rates set by the Fed.

Reacting to that move, some investors and analysts said it was reasonable to wonder if the Fed might slow its pace of interest-rate increases after considering their possible role in the recent market volatility.

Others, though, dismissed that thinking, arguing that the Fed would continue to raise rates at exactly the pace it felt it needed to bring down inflation absent a much more serious breakdown in U.S. trading conditions.

For that reason, “relief [for U.S. bond prices] is likely to be temporary,” Roberto Perli and Benson Durham of Piper Sandler wrote in a note to clients Wednesday.

One point of agreement is that the Fed’s actions have consequences beyond the U.S. economy.

By moving earlier and faster to raise interest rates than many other central banks, the Fed has helped strengthen the dollar against other currencies. That in turn has put extra pressure on other central banks to raise rates quickly, so that their currencies don’t continue to weaken in a way that further stokes inflation in their economies.

Recent moves by global central banks to aggressively lift rates have contributed to selling of Treasurys, according to analysts, as rising yields abroad give investors more buying options.

Treasury yields are largely determined by investors’ expectations for what overnight interest rates set by the Fed will be over the life of a bond. They in turn set a floor on borrowing costs throughout the economy.

Heading into this year, many economists and Fed officials thought that rising inflation would fade by itself or with only mild intervention from the central bank. Wall Street analysts had typically guessed the Fed would raise interest rates by less than a percentage point in 2022.

Instead, Fed Chairman Jerome Powell has led the central bank through its most aggressive series of rate rises in decades. After raising rates by a quarter of a percentage point in March and half a percentage point in May, the Fed lifted them by three-quarters of a percentage point at its June meeting, a move without precedent since the 1990s. Then it repeated that step twice more, in July and September, bringing the benchmark fed-funds rate to a range of 3% to 3.25%.

“I don’t think that this was in the range that anyone was talking about,” said Natalie Trevithick, head of investment-grade credit strategy at Payden & Rygel.

Most traders are convinced that more steep hikes will follow, with annual inflation still above 8% and underlying inflation pressures—such as the pace of wage growth—showing few signs of easing. Derivatives-market bets now show expectations that rates will climb above 4.75% by the middle of next year. In recent days, some Wall Street firms have predicted the Fed will take rates above 5%.

source :- wsj