Treasury 10-Year Yield Tops 5% for First Time Since 2007

What You Need to Know

The rise in yields means higher borrowing costs for businesses, which caused stocks to retreat early Monday.
The rise in yields has humbled the giants of the financial world, some of whom predicted that 2023 would prove to be a good yea for bonds.
Longer-term, rates may be pushed above the levels of recent history; and Bloomberg predicts a nominal 10-year bond yield in the region of 6%.

The 10-year Treasury yield crossed 5% for the first time in 16 years, propelled by expectations the Federal Reserve will maintain elevated interest rates and that the government will further boost bond sales to cover widening deficits.

The yield rose as much as 11 basis points to 5.02%, the highest since 2007.

Fed Chair Jerome Powell suggested last week that central bankers are inclined to hold rates steady at their November meeting, but remain open to hiking again if a resilient economy fans inflation risks.

Meanwhile, bond investors are being asked to buy increasing quantities of Treasury notes and bonds. The U.S. budget deficit has grown, in part because of rising interest costs.

At the same time, the Fed isn’t replacing all of the Treasuries on its balance sheet as they mature. Dealers estimate that the outstanding debt will increase by $1.5 trillion to $2 trillion in 2024, vs about $1 trillion this year.

“Yields are rising because we are finally seeing supply come in,” Tom Tzitzouris, head of fixed income research at Strategas Research Partners said on Bloomberg Television Monday. Fed rate increases and balance-sheet reduction “is catching up with the bond market now.”

US 10-Year Yield Rises to 5% for First Time Since 2007 | Traders are wagering the Fed will keep policy rates high for longer

The U.S. Treasury increased the size of its quarterly bond sales for the first time in 2 1/2 years in August, and Secretary Janet Yellen’s department is now readying its November financing plans.

Yields haven’t been this high since the era that preceded the Fed’s experiment with unconventional policies — near-zero benchmark rates and quantitative easing — aimed at shoring up an economy that had been rocked by the sub-prime mortgage crisis and collapse of Lehman Brothers.

Those policies were implemented on and off for 15 years until the pandemic, and the wave of government spending it triggered, fueled an inflation surge that forced policy makers to raise interest rates closer to the norm seen for decades.

The Treasury market is the world’s biggest bond market, and Treasury yields are considered risk-free rates of return for the purposes of comparison with other investment opportunities.

The rise in yields translates into higher borrowing costs for households, businesses and governments in the U.S. and abroad. Stocks retreated worldwide Monday.

No ‘Year of the Bond’

The rise in yields has humbled the giants of the financial world, some of whom predicted that 2023 would prove to be the “year of the bond.”

The 10-year yield began this year at around 3.90%, and most Wall Street firms expected that it would decline as the Fed rate increases that began in March 2022 took their toll on the economy and brought inflation to heel. Among major dealers, Goldman Sachs had the most bearish forecast, calling for a year-end level of 4.3%.

More recently, disdain for bonds has been powerful enough to offset haven flows into U.S. debt as the Israel-Hamas conflict reignited geopolitical worries.

What Strategists Say

“After more than a year of being inverted, some of the key segments of the Treasury curve are about to revert to zero. That is usually taken as an imminent sign that the economy is about to contract or even entered a recession — but that isn’t the case this time around. It has more to do with a higher neutral rate and rising real-risk premiums,” according to Ven Ram, Bloomberg’s macro strategist.

“While levels look attractive in the near term, investors are likely to continue waiting for catalysts (such as geopolitical risks or slowing data) rather than catching the falling knife amid technical weakness,” Gennadiy Goldberg and Molly McGown, strategists at TD Securities wrote in a recent note. “This could keep rate volatility extremely high in the near-term.”

Still, 10-year Treasuries above 5% are a buy for Morgan Stanley Investment Management, which sees yields overshooting the firm’s fair value above that level.

Another emerging threat to Treasurys is the changing composition of the market. The Fed is reducing its bond holdings via quantitative tightening, while the holdings of foreign governments such as China’s are waning. In their place, hedge funds, mutual funds, insurers and pensions have stepped in.

The fact that they are less price-agnostic than their predecessors is leading to the revival of the the so-called term premium for bond pricing. That’s where investors seek higher yields to compensate for the risk of holding longer-dated debt.

Longer-term, rates may be pushed above the levels of recent history. A new Bloomberg Economics report concludes the combined impact of persistently high levels of government borrowing, more spending to fight climate change and faster growth will mean a nominal 10-year bond yield in the region of 6%.

In the immediate future, the Treasury market remains on course for an unprecedented third year of annual losses.

Higher borrowing costs may ultimately serve as a brake on the U.S. economy, helping the Fed’s inflation fight. The average rate on a 30-year fixed mortgage soared to around 8% in recent weeks, while the cost of servicing credit card bills, student loans and other debts has also climbed as market rates rose.

Powell echoed some of his colleagues by saying a sustained rise in yields could “at the margin” lessen the pressure for tighter monetary policy. Bloomberg Economics reckons if the recent increase is sustained, it’s the equivalent of about 50 basis points of Fed tightening.