Why a Spike in US Bond Yields May Be Coming

Amid signs that risk aversion is abating, it may not take much more for U.S. Treasury yields — which have been low for so long now — to spike higher, some analysts say.

U.S. Savings Bonds
U.S. Savings Bonds

According to Thierry Apoteker, CEO of research group TAC Financial, the buildup of a bond bubble could trigger a sharp sell-off in U.S. Treasurys that could push 10-year yields up between 80 and more than 100 basis points next year.

Benchmark 10-year U.S. bond yields are currently trading around 1.62 percent, not too far from the record lows hit just two months ago of close to 1.40 percent. Weak economic growth, easy monetary policy and the euro zone debt crisis have boosted demand for safe-haven U.S. bonds, leading to some talk of an asset bubble in the world’s largest bond market.

“We are getting into bubble territory,” Apoteker told CNBC Asia’s “Squawk Box” on Tuesday, as he flagged the risk factors that potentially await investors. “The U.S. 10-year bond yield could move to 2.5 and 3 percent next year, which would be a big risk for bondholders.”

Apoteker says worries about the euro zone debt crisis and sluggish economic growth in emerging market economies have kept safe-haven Treasury yields artificially low and the danger, as the outlook for global growth improves and fears about Europe’s bond crisis ease, is a sharp unwinding of money flows into U.S. bond markets that could spark a sharp rise in yields.

He says there are some signs of that happening already, with U.S bond yields creeping higher over summer after steps by Europe’s policy makers to end the debt crisis boosted risk appetite.

“Our models suggest that 10-year U.S. Treasury yields should be trading at 2.5 percent now, but they are not there because Treasurys have been bought as the ultimate liquid safe asset,” he said. “So if there are any improvements in the perception that risk is subsiding, that could lead investors to offload those Treasury assets and if that happens quickly it would be dangerous for the bond market because it would lead to a weaker dollar.”

Don’t Forget the Economy

Other analysts say signs of a pick-up in the U.S. economy will also push up Treasury yields.

“We still remain of the view that the macro economic situation will be okay, we will see growth it will not be stellar. Nevertheless the economic situation will be positive,” Francois Savary, chief investment officer at Reyl Bank told “Squawk Box,” adding that a rise in in 10-year yields to 2.5 percent was feasible over the next 18 months.

The U.S. manufacturing sector grew in September after three months of contraction, the Institute for Supply Management said on Monday.

“Just growth that’s not uneven would put pressure on bond yields,” said Russell Jones, global head of fixed income strategy at Westpac Bank in Sydney.

Indeed, Treasury prices slipped on Monday after the strong manufacturing report.

“Markets start to romance about expectations for growth and inflation and that is why we start talking about yields going up to 2.5 percent, this is a level that tends to stick out,” said Timothy Riddell, head of global markets research at ANZ bank in Singapore

But Riddell adds there are important reasons why a sharp rise in yields is unlikely.

“A spike in bond yields is something we have to consider. But the rhetoric from the Fed is that rates are going to be low for a period of time, so I think yields will struggle to get above 2 percent,” he said.

The Federal Reserve has said it will leave interest rates near zero until mid-2015 to allow time for a recovery to take hold. The central bank chief Ben Bernanke in a speech on Monday said that inflation had fluctuated close to the its target of 2 percent and that inflation expectations have remained stable.

“We need to see a different environment — one where a period of growth is not followed by a period of weakness to see a sustained rise in yields,” said Westpac’s Jones.

—By CNBC’s Dhara Ranasinghe