What will happen to the 10-year U.S. Treasury yield, now that the Federal Reserve appears intent upon cutting its benchmark short-term rate? That is really hard to say, because, among other things, the 10-year yield has been so volatile.
The 10-year has been on a wild ride, with its yield starting 2024 at 3.95%, climbing to 4.7% by spring (when people were more leery of persistent inflation than they are now) and lately falling back below its January starting point, at 3.8%. The 10-year is more subject to market forces than are short-term bonds, over which the Fed has greater control.
The Fed raised short-term rates robustly during a 16-month period that ended in July 2023. Now, though, the bond market expects a series of rate cuts from the Federal Open Market Committee starting in September, which Fed Chair Jerome Powell has broadly suggested.
“Ultimately, declining yields on the long end of the bond market reflect long-term inflation and economic growth expectations,” commented Rob Haworth, senior investment strategy director for U.S. Bank Wealth Management, in an analysis. “The short end of the yield curve has mostly held steady, more directly anchored to the Fed’s stance on the fed funds rate.”
The upshot is an inverted yield curve over the past two years. (The inversion classically has been a recession portent, but that outcome thus far has not occurred.) The 10-year now yields about 1.4 percentage points fewer than the three-month Treasury bill.
Lower rates will have many salutary effects on consumers; mortgage rates, for instance, are likely to decline. For pension funds, the value of the bonds in their portfolios will no doubt increase.
On the other hand, sponsors may well end up having to contribute more to their funds, because, when interest rates drop, liabilities (the discounted value of future cash flows) often rise. Asset allocators use a discount rate linked to long-term rates when calculating liabilities.
The big swings in the 10-year yield appear to be rooted lately in crowd psychology more akin to the stock market than the bond market. In short, bond investors’ perceptions have been flawed, wrote Thomas Aubrey, the founder of consulting firm Credit Capital Advisory, in a commentary.
“The market assumed that the U.S. economy was heading for a recession and required more accommodative monetary conditions,” he argued. “This negative outlook has been influenced by the pervasive loose monetary policy that was put in place in 2009, with investors believing that the economy needs lower interest rates in order to function.”
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Tags: 10-Year Treasury, Bond Market, Federal Reserve, Interest Rates, Jerome Powell, Recession, Yield Curve, yields