The Roots of Rising Treasury Yields

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After years of decline, why did U.S. Treasury bond yields rise substantially in the second half of 2016? Foreign central banks reducing their holdings of Treasuries, a global deal to cut oil production and the results of the U.S. elections helped spur last year’s rapid rise in yields, according to a recent article in The Regional Economist.

Economist Paulina Restrepo-Echavarria and Senior Research Associate Maria Arias said foreign central banks and other international institutions have been steady buyers of U.S. Treasuries since 2008. However, these institutions have trimmed their holdings of U.S. Treasuries since the size of their holdings peaked in 2015.

China and Japan, the two countries holding the most U.S. government debt, had different reasons for reducing their holdings of U.S. Treasuries.

“China has been selling U.S. Treasuries to defend its yuan in the face of capital outflows due to slower growth,” Restrepo-Echavarria and Arias wrote. “Japan has been swapping Treasuries for cash and T-bills because its prolonged negative interest rates have increased the demand for U.S. dollars.”

Though Treasury holdings by foreign official institutions have declined since 2015, the authors said that U.S. Treasury yields were more or less stable until the latter half of 2016. They noted that the yields on two-year, 10-year and 30-year Treasuries increased 0.24, 0.44 and 0.45 percentage points, respectively, between their lowest point on the week ending July 6 and the week ending Nov. 2.

Restrepo-Echavarria and Arias identified two key events that also contributed to the rapid rise in U.S. Treasury yields:

• The U.S. national elections in November
• The agreement by major oil-producing countries to cut crude oil production

The authors noted that following the U.S. elections, expectations shifted with the anticipation of aggressive fiscal policy changes, including higher infrastructure spending, financial deregulation and a major tax overhaul. They added that, in theory, such changes could lead to higher economic growth rates and a quicker pace of inflation.

“But these policy changes would also lead to higher-than-anticipated levels of U.S. government debt and a growing deficit, and, together with the deal to cut crude production, would reinforce expectations of higher inflation,” the authors pointed out.

They explained that these worries spurred investors to sell a massive amount of U.S. and foreign bonds in the weeks following the U.S. elections, causing yields to spike. They noted that in the weeks between Nov. 2 and Dec. 7, yields on two-year, 10-year and 30-year Treasuries increased 0.30, 0.58 and 0.50 percentage points, respectively.

• The Regional Economist: After Years of Decline, Yields on U.S. Treasuries Rise
• On the Economy: China’s Efforts to Boost the Yuan
• On the Economy: Where Is the Federal Budget Going?