Investors find themselves in a state of amazement as they witness the rapid ascent of US government bond yields, raising concerns due to eerie parallels with historical economic downturns. The last time US government bond yields surged so swiftly, the nation grappled with consecutive recessions. The 10-year Treasury yield, a vital benchmark for the cost of borrowing across the financial landscape, has leaped by over four percentage points in the past three years, briefly surpassing the 5% mark this week for the first time since 2007. This surge mirrors the steep climb witnessed during the early 1980s when Paul Volcker’s efforts to combat inflation sent the 10-year yield soaring to nearly 16%.
One could argue that the similarities are not entirely unexpected, given the aggressive interest-rate hikes by Fed Chair Jerome Powell, reminiscent of the Volcker era. However, it underscores just how much the economic landscape has transformed since then.
During the 1980s, the relentless monetary policy measures triggered two recessions. Presently, the economy has defied pessimistic forecasts, with estimates from the Atlanta Fed suggesting it may have even gained momentum in the third quarter.
Admittedly, the policy stance during the Volcker era was considerably more stringent. When adjusted for consumer price increases, the “real” 10-year Treasury yield, or the yield after factoring in inflation, was approximately 4% when the second downturn of that period began in mid-1981. Today, it hovers around 1%.
Nonetheless, the surprising resilience of the economy has introduced significant uncertainty into the markets. Bond yields have surged significantly over recent months, fueled by growing convictions that the Fed will maintain high-interest rates.
The sustainability of this resilience remains uncertain. Billionaire investor Bill Ackman, for instance, recently closed his bearish bets against long-term bonds, citing a rapidly slowing economy.
Yet the year began with similar predictions, alongside expectations that the bond market would rally as the Fed altered its course. Instead, bond prices have continued to decline. The Bloomberg US Treasury Total Index has fallen by about 2.6% this year, extending losses to 18% since its peak in August 2020. In comparison, the most significant peak-to-trough decline before this was about 7% in 1980, when the Fed’s key benchmark reached 20%. This selloff has been more painful due to the previously low rates, which depressed income payments intended to offset losses.
Another contributing factor has been the substantial increase in the federal deficit, flooding the market with new Treasuries precisely when traditional prominent buyers, including the Fed and major central banks, have scaled back their bond purchases. This phenomenon is one reason yields have continued to rise in recent weeks, even as the futures market indicates that traders believe the Fed’s rate hikes may be nearing an end.
Market sentiment is marked by uncertainty, as Priya Misra, a portfolio manager at JPMorgan Asset Management, observed, “A hard landing is sort of our base case scenario — but I can’t point to any data and say, ‘This is a clear leading indicator of a recession and look right here.’ Conviction levels are low, and investors who had been buying bonds have all been hurt.”
