The 10-year Treasury yield is currently approaching 5%, a level not seen in 16 years. Strategists at Barclays have made it clear this week that Federal Reserve policy is not overly tight, and they do not anticipate a swift decline in interest rates. So, what can history tell us about the rise in US bond yields and what lies ahead for Treasurys?
Investors have been selling off US government bonds, reacting to the prospect of higher interest rates that could persist for an extended period. This Treasury sell-off, which began in early October, is considered one of the most significant market crashes in recent history. Just last Friday, the 10-year Treasury yield touched 5% for the first time since 2007.
Despite the market’s concerns and panic, historical data suggests that current yields align with medium-term economic expectations. Christoph Schon, a senior principal at Qontigo, points out that a 10-year yield in the range of 4.7% to 5.1% appears reasonable relative to the long-term inflation expectations of about 2.45%. Looking back to the 1980s and 1990s, the 10-year Treasury yield was typically twice the inflation expectations, indicating that investors could anticipate real returns that matched expected inflation rates.
However, a shift occurred with the dot-com bubble and the 2008 financial crisis. During this time, Treasurys became a preferred choice for investors seeking a safe haven while the stock market experienced prolonged volatility. Schon notes that with the recent surge in consumer prices and global events like the pandemic and Russia’s invasion of Ukraine, stocks and bonds have once again become correlated. Both are selling off in response to the sharp increase in interest rates.
Schon’s argument is that the current environment resembles the pre-2000s era when Treasury bonds were an attractive alternative to equities, not just a safe haven during turbulent times. Historical patterns suggest that investors would be seeking yields between 1.9 and 2.1 times inflation expectations. With the current 10-year breakeven rate at 2.45%, this implies a corresponding nominal yield between 4.7% and 5.1%.
When it comes to predicting where the key bond yield is headed next, history offers some guidance. Schon suggests there is a less than 1% probability that the 10-year Treasury yield will surpass 5.5%, unless there is a substantial upward revision in inflation expectations.
Federal Reserve Chief Jerome Powell has indicated that policymakers will let the bond market volatility run its course, acknowledging that rising yields have tightened financial conditions. Market sentiment, as reflected in the CME FedWatch Tool, currently shows a 98% likelihood of no rate hike at the November 1 Fed meeting and a 24% chance of a 25 basis point hike in December.
However, other strategists warn that there is still a possibility of yields climbing higher. Some, like Phillip Colmar from MRB Partners, predict yields breaching 5.5% in 2024. Adam Phillips of EP Wealth Advisors suggests that a potential government shutdown in November could further push yields upward.
Barclays strategists have noted that the 10-year yield remains below the expected terminal rate for the Federal Reserve’s ongoing hiking cycle, which deviates from how tightening cycles usually conclude. They argue that the hurdles for a bond rally remain high, emphasizing that policy is not particularly tight, and risks lean toward continued upside surprises.
In summary, the surge in Treasury yields is a topic of considerable interest, and historical context offers valuable insights into potential outcomes. The future trajectory of bond yields remains subject to various economic and policy factors, keeping investors and strategists closely tuned to market developments.
