The recent surge in long-dated Treasury yields can be attributed to a key factor: higher real rates resulting from shifting expectations for U.S. economic growth. According to Joseph Kalish, the chief global macro strategist at Ned Davis Research, this factor alone accounts for about 90% of the increase.
Significant increases in yields have been observed across various Treasury maturities. The 5-year, 7-year, 10-year, and 20-year Treasury yields (BX:TMUBMUSD05Y, BX:TMUBMUSD07Y, BX:TMUBMUSD10Y) have all experienced substantial growth since 2021-2022. On Monday, the 10-year rate reached a nearly 16-year high of 4.339%, indicating the magnitude of this upward trend.
Furthermore, the 5-year Treasury yield, which represents the intermediate portion of the Treasury curve known as the “belly,” has also witnessed an increase. This can be attributed to traders and investors incorporating expectations for a stronger U.S. economy beyond the next few years into their decisions.
The upward trajectory in long-dated Treasury yields is primarily driven by changing outlooks for U.S. economic growth, as real rates continue to rise. These developments have significant implications for various sectors and financial markets as traders and investors adjust their strategies accordingly.
Rise in Treasury Yields: A Different Scenario
Ordinarily, Treasury yields tend to rise for various reasons, including the anticipation of higher future inflation and investors seeking compensation for the associated risks. However, the current situation seems to be unique. Real rates, which are measured by yields on Treasury inflation-protected securities, provide us with a clearer understanding of the economy’s performance when inflation is factored out. Presently, real yields are increasing based on encouraging economic data, giving investors some hope for a soft landing. This refers to a scenario where inflation naturally decreases without a recession or a significant rise in unemployment.
According to a note distributed on Tuesday, bond yields have experienced a rapid increase recently. This surge can be attributed mostly to higher real yields, although the increased supply of U.S. government debt is likely playing a role as well.
As of Monday, 10- and 30-year Treasury yields (BX:TMUBMUSD30Y) have seen substantial jumps of 105.4 basis points and 91.7 basis points respectively since early April. These yields closed at their highest levels since November 6, 2007, and April 27, 2011. Currently, they stand at around 4.321% and 4.426% respectively, with Tuesday afternoon seeing a pause in the aggressive selloff of long-dated government debt witnessed in the past week.
Underestimating Risk and Overvaluing Cuts
Kalish astutely points out that the market has not fully accounted for the potential ramifications of additional rate hikes. Contrary to prevailing beliefs, Kalish suggests that the risk associated with these hikes has been consistently underpriced. On the other hand, the market has overly exaggerated the speed at which rate cuts are expected to take place. This discrepancy in expectations requires closer examination as it holds significant implications for investors and traders alike.
Powell, as he prepares for his address, is expected to harbor several sentiments regarding the current economic landscape. Firstly, he is likely to express satisfaction at the progress made in terms of goods inflation. This positive development indicates a healthier market environment. Secondly, he is hopeful that the labor market is moving towards better equilibrium, bringing about increased stability and efficiency. Lastly, he remains cautiously concerned about the economy outpacing its expected growth trajectory, potentially leading to unforeseen challenges.
As we eagerly await Jerome Powell’s Jackson Hole address, it is essential to recognize the market’s tendency to misjudge the risks and expectations surrounding rate hikes and cuts. Kalish’s astute observations shed light on this discrepancy, emphasizing the need for a more informed approach to investment decisions. Powell’s address is anticipated to provide further insights into his assessment of the current economic landscape, allowing traders and investors to recalibrate their strategies accordingly.