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- The yield on the 10-year Treasury is hovering close to 5%, the highest level in 16 years.
- Strategists at Barclays this week said Fed policy isn't even very tight and rates won't fall soon.
- Here's what history says about the rise in US bond yields and where Treasurys may be headed next.
Investors have been dumping US government bonds as the market adjusts to the outlook of interest rates being higher for longer.
The Treasury sell-off that started in early October has ranked among the worst crashes in market history, and as recently as Friday the yield on the 10-year Treasury touched 5% for the first time since 2007.
Despite the panic in markets, trends from decades past suggest that yields are pretty much right in line with expectations for the economy over the medium-term.
Christoph Schon, senior principal of applied research at market data and intelligence firm Qontigo, told Insider that a 10-year yield at 4.7%-5.1% looks appropriate relative to the current long-term inflation expectations, which stand at about 2.45%.
During the 1980s and 1990s, he explained, the 10-year Treasury yield was roughly two times inflation expectations, represented by the 10-year breakeven inflation rate. At the time, investors could expect real returns that matched the expected rate of inflation.
It took the dot-com bubble and 2008 financial crisis to shift this, however, and Treasurys became assets where investors could park cash while the stock market went through a long period of volatility.
"Stock and bond prices started to move in opposite directions, complementing each other depending on risk appetites," Schon said.
He added that the recent surge in consumer prices with the pandemic and Russia's invasion of Ukraine has meant stocks and bonds are correlated once again, with both assets selling off in tandem amid a sharp rise in interest rates.
"Our argument is that the current environment is more like the pre-2000s, in which Treasury bonds were an attractive alternative to equities, not just a safe haven in times of turmoil," Schon said. "History suggests that the yield that investors would be looking for would be somewhere between 1.9 and 2.1 times inflation expectations. The current 10-year breakeven rate of 2.45% would therefore imply a corresponding nominal yield of between 4.7% and 5.1%."
As for where the key bond yield heads next, history points to an answer there, too. There's a less than 1% probability, he says, that the 10-year Treasury yield climbs above 5.5% barring any significant revision higher in inflation expectations.
In Thursday comments in New York, Fed chief Jerome Powell said policymakers will let the bond market volatility play out, and that rising yields have helped tighten financial conditions. Currently, the CME FedWatch Tool shows markets are pricing in 98% odds of no hike at the Fed's November 1 meeting, and a 24% chance of a 25 basis point hike in December.
Other strategists have warned that there's still a chance yields run higher. Phillip Colmar, global strategist at MRB Partners, predicted they could indeed breach 5.5% in 2024, and Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors, said a potential government shutdown in November could be an additional factor that pushes yields higher.
On Wednesday, Barclays strategists pointed out that the 10-year yield remains below the expected terminal rate for the Federal Reserve's current hiking cycle, which is at odds with how tightening cycles usually end.
"The hurdle for a [bond] rally is still high," the strategists said in a Wednesday note. "Despite data continuing to show a resilient economy, the consensus still expects it to slow very sharply over the coming quarters. Repeated misses beg the question whether the consensus has been overly confident about monetary policy being too tight. We argue that policy is barely tight and risks are skewed towards continued upside surprises."