- Last week, we saw new highs in Treasury yields, as the 10-year yield reached 3.86% and the two-year yield hit 4.6%.
- The recent highs in Treasury yields were driven by the fact that the latest data on labor and prices in the US indicated that the economy still has a long way to go to bring down inflation.
- An inverted yield curve, which is currently being observed, has historically been a predictor of an impending recession.
Last week, short-term US Treasury yields surged to their highest level since July 2007 following the release of new official data indicating that the US economy remains robust. Furthermore, the ten-year Treasury yields, often used as a barometer for the economy, climbed to their highest point since December 30.
Wall Street is concerned about a possible recession due to the recent rise, while the Federal Reserve is even more committed to implementing additional interest rate hikes. Let’s examine the situation to understand better the reasons behind the increase in yields and the likelihood of continued inflation. Meanwhile, as the Fed addresses inflation, you can handle your portfolio. Our Inflation Protection Kit utilizes artificial intelligence to identify the top stocks and ETFs poised to maintain their value in the face of inflation, offering you the most incredible opportunity to navigate this challenging period.
US Treasury yields up to 2007 levels
Last week, the 10-year US Treasury yields rose to their highest point in two months, peaking at 3.86% before slightly retreating to 3.82% by Friday.
Likewise, other yields experienced a similar pattern, with the two-year Treasury yield reaching 4.6% and one-year yields briefly touching 5%. The most recent occurrence of the latter reaching such levels was in July 2007.
Elevated yields can impact the value of bonds, widely regarded as the ultimate secure investment. They have displayed sensitivity to the latest information regarding the state of the US economy, which has not behaved as the Federal Reserve anticipated.
However, what specific data is contributing to the increase in Treasury yields?
What is causing yields to rise?
In early February, the Federal Reserve continued to apply the brakes on massive interest rate hikes that commenced in March 2022. The most recent hike was only a quarter-point increase, starkly contrasting the considerable strides taken last year.
During that period, inflation was perceived to be subsiding. It had decreased for seven consecutive months, plummeting from its peak of 9.1% in June of the prior year to 6.5% by December, and the most challenging period had already passed.
Nonetheless, additional information has disrupted the status quo and clearly warned that further interest rate hikes may be forthcoming.
The unemployment rates in the United States have reached their lowest point in 53 years, falling to 3.4%. Creating jobs was much more robust than anticipated, with 517,000 new positions added in January compared to analysts’ projections of 185,000.
The inflation reading for January 2023 was the subsequent dataset to challenge expectations, surging at a rate of 6.4% rather than the projected 6.2%. This slight uptick, along with the employment news, sounded the alarm across Wall Street.
The situation has remained the same since then. The producer price index, which monitors wholesale prices, increased to an annual rate of 6%, surpassing the anticipated decrease to 5.4%.
Retail sales in the United States surged by 3%, marking the most substantial uptick in nearly two years and indicating that consumers are still spending despite the burden of borrowing. This may have been fueled by the cost-of-living adjustment for the 65 million Social Security beneficiaries nationwide.
Although this is encouraging news in the short run for avoiding a recession, it makes the Federal Reserve’s task much more challenging in terms of curbing long-term inflation, which, in turn, compels Treasury yields to behave erratically.
Why does it matter?
Treasury yields have significant implications, as they determine the cost of borrowing money for the US government, the interest rates received by bond investors, and the interest rates paid by everyone on their loans.
The 10-year Treasury yield is considered the pinnacle, as it is utilized to gauge mortgage rates and market confidence. If these yields soar, it could further impede the housing market’s progress.
Currently, we are witnessing an inverted yield curve, where short-term yields offer higher returns than long-term yields. In the past, an inverted yield curve has been an indication of an impending recession, which may cause banks to be hesitant about lending.
The Federal Reserve is facing another challenge with the tight labor market, as it’s currently an employee’s market driving up wage growth. This, in turn, has led to a steady rise in Treasury yields, compounded by stronger-than-expected price indexes.
Increasing interest rates to curb inflation has the potential to widen the inverted yield curve, which is already a concern. This is because higher interest rates affect short-term yields, which may result in an even greater gap between short-term and long-term yields. If the curve continues to invert, it could indicate an impending recession, depending on other economic data.
How are the markets reacting?
Last week saw a reverse correlation between Treasury yields and the stock market – as yields increased, the stock market tended to decline.
By the end of the week, the S&P 500 had closed 0.3% lower, with Thursday being its worst day in a month. The Nasdaq Composite also experienced a 0.6% drop, adding to the market’s overall gloom.
If Treasury yields keep climbing, we can expect to see more instability in the stock market.
Is Inflation here to stay?
There are numerous economic indicators that are used to assess the health of the economy. However, the recent data points defy traditional economic logic, with inflation showing no signs of abating.
Just a few weeks ago, investors were anticipating interest rate cuts by the end of the year. However, the outlook has since become considerably bleaker, with some expecting interest rates to climb as high as 5.5%.
Last week, Cleveland Fed President Loretta Mester made it clear that the Fed officials are expecting a significant improvement in inflation in the near future. Mester stated that her expectation was “that we will see a meaningful improvement in inflation this year and further improvement over the following year, with inflation reaching our 2% goal in 2025”.
St. Louis Fed President James Bullard recently suggested that a half-percentage point increase in interest rates was a possibility for the upcoming meeting.
If that materializes, the impact on the two-year Treasury yield will be significant, as it is highly sensitive to interest rate hikes. Analyzing the movement of the two-year Treasury yield will help us better understand the direction in which the economy is headed.
The bottom line
Meanwhile, the yield rates will be closely monitored to determine if this is just a temporary spike or the start of a more significant trend. However, one thing is clear: inflation is currently persistent, and the Fed is likely to maintain its commitment to raising interest rates in order to bring it under control.
Source: Forbes
