Markets Threatened as US Plans to Sell $258b of Debt

As investors come to terms with the impending end of easy monetary policy, a new threat looms: The heavy supply of US Treasury could bump up bond yields and place greater pressure on stock prices.

Stock markets globally came under heavy selling earlier this month after signs of higher inflation gave rise to fears that the Federal Reserve could hike interest rates at a quicker pace.

Investors are getting used to that now, said PIMCO, but the stock market could be rattled again if there isn't enough demand for the large supply of treasury. "I think the market's starting to come to terms with these higher rates," Mihir Worah, PIMCO chief investment officer for asset allocation and real return, told CNBC Wednesday.

"It's not just the Fed and inflation coming higher that the market has to get used to, but also treasury supply. Given the big deficits and tax cuts, there's going to be tremendous treasury supply in the United States."

The US Department of Treasury is expected to sell $258 billion worth of debt this week. Among the issuance so far is the auction of $28 billion in 2-year notes at a high yield of 2.255%—the highest since August 2008.

That, coupled with the release of stronger-than-expected inflation data, saw the 2-year treasury yield hit its highest level in nearly 10 years.

Higher bond yields when interest rates and inflation are rising may prompt investors to shift funds from stocks to bonds. Such an environment threatens the stock market because stronger inflation eats away at corporate profit margins, and higher interest rates make borrowing costs higher for investors and businesses.

"If yields go up modestly because we're moving from a time where we worry about deflation to a time where we expect modest 2 to 2.5% inflation, that's fine," Worah said.

But yields could also creep up when inflation rises faster than expected, or when "there's too much supply of treasury, too little demand"—scenarios that the stock market should worry about, he added.

European Stocks Fall

European stocks on Wednesday were dragged lower, as investors received disappointing updates on manufacturing and services activity in the eurozone and saw a break in the recovery run for US stocks, MarketWatch reported.

The Stoxx Europe 600 index fell 0.8% to 377.60 as only the telecommunications group posted a small gain. Tech and utility stocks were losing the most. On Tuesday, the benchmark rose 0.6%.

Germany’s DAX 30 index fell 0.7% to 12,401.35, and Spain’s IBEX 35 dropped 1% to 9,799.40. France’s CAC 40 gave up 0.6% at 5,256.65, and the UK’s FTSE 100 shed 0.3% at 7,223.53. The yield on the 10-year German bond fell 3 basis points to 0.70%, according to Tradeweb. Yields fall when prices rise.

Asia Rises

Asia technology shares led gains while commodity producers paced declines after US equities halted a six-day rally and bond yields rose. Hong Kong’s benchmark climbed while Taiwan stocks, which resumed trading after the Lunar New Year holiday, climbed the most since September 2015, Bloomberg reported.

The MSCI Asia Pacific Index rose 0.3% to 177.19 in Hong Kong, after earlier sliding by the same magnitude. The S&P 500 lost 0.6% Tuesday while shorter-dated treasuries fell after a heavy US debt issuance. The Fed will today release minutes of its recent meeting, helping investors gauge prospects of interest rate rises.

Japan’s Topix index swung between gains and losses as banks and drugmakers fell, while exporters including automakers and technology shares advanced as the yen weakened for a fourth day. The Taiex jumped 2.8% in Taipei, with Taiwan Semiconductor Manufacturing Co. rallying 2.5% after it was raised to outperform at Credit Suisse Group AG.

Hong Kong stocks rebounded from Tuesday’s loss as trading on the mainland is scheduled to resume Thursday. Australia’s benchmark equities index was little changed, with BHP Billiton Ltd. sinking 4.8% after its first half profit missed analyst estimates. The Philippine Stock Exchange Index halted a five-day rally as Ayala Land Inc. lost 2.2% after UBS Group AG cut its rating to neutral.