REUTERS/Jonathan Ernst
- The 10-year Treasury yield is firmly above 4% in August, helping to stall the stock market's strong 2023 rally.
- But with the end of rate hikes in sight as inflation keeps falling, yields should theoretically be doing the opposite.
- Here's why Treasury yields have been steadily moving up this month.
The 10-year Treasury yield hit the highest level since 2008 on Thursday, touching 4.30%, a huge jump from this year's trough of 3.68% notched in April. Rising yields have dented the stock market's stellar 2023 rally, confounding and frustrating markets that see an end in sight to the Federal Reserve's rate hiking campaign amid dwindling inflation.
So with prices cooling and the Fed likely to stop raising rates this year, why are yields marching ever higher?
Strong economy
The first reason is the simplest. The economy is just too strong to support the near-term recession narrative any longer. In times of stress, investors will flock to safe havens like US Treasury bonds, driving yields lower. Now however, markets have pushed out their expectations for a downturn to the first quarter of next year at the earliest.
"The continued strength of the US economy, in spite of one of the most aggressive Fed rate hiking campaigns in decades, has caused the bond market to start to price out the immediate risk of recession. Moreover, it is pricing out the immediacy of interest rate cuts as well," Lawrence Gillum, chief fixed income strategist at LPL Financial, said.
That last point about pricing out immediate rate cuts is important. The Fed managed to thread the needle, leaving the economy intact while bringing down inflation, so it likely sees little need for a rate cut until the economic data starts to sour.
For now, the market's "higher for longer" narrative is dominant, keeping rates elevated even as consumer and wholesale prices steadily fall. Or, in the words of JPMorgan analyst Brandon Hall, the market is "pushing out rate cuts, not pulling forward more hikes."
Treasury supply
Another reason yields are up is that there is an enormous amount of Treasury supply hitting the market. Recall that bond yields rise as prices fall, and when supply of something increases it weighs on prices.
The Treasury will issue $1 trillion of bonds this quarter alone, and another $852 billion next quarter, as federal budget deficits deepen.
"This additional supply is at a time when the Fed is shrinking its holdings of Treasuries, a process that effectively forces the government to sell more to the public," Hall said.
Other central banks
Actions taken by foreign central banks can also weigh on bond prices and push yields higher. The Bank of Japan's surprise move to loosen control of its government bonds sent those yields higher, making them more attractive to domestic investors at the expense of US Treasurys.
These explanations may not necessarily soothe jittery stock investors who have watched the market rally screech to a halt in August. Tech stocks in particular are threatened by rising rates as their high-growth narrative is reliant on cheap debt and few alternatives for investors to find such juicy returns.
Experts predict yields will continue to trend a bit higher for the year, and some say the 10-year Treasury yield at 4.5% next quarter is not out of the question.
"Our base case remains that the U.S. economy will slow down/contract due to the elevated interest rates caused by the Fed rate hiking campaign," LPL's Gillum said. "So, while we still think the 10-year yield ends the year lower, as long as economic data continues to surprise to the upside, Treasury yields may remain above our 3.25%–3.75% target range in the interim."