Treasury Yields Touch 20-Year Highs, Fueled by Sticky Inflation, US Debt

You know the deal by now. US bond yields are rising because investors are worried about persistent inflation, fueled by higher oil prices, which could drive up interest rates. At the same time, the rationale for rate hikes has been strengthened by a surprisingly resilient American economy that looks like it can absorb them. Meanwhile, the rapidly growing, supersized US debt pile means the Treasury has to keep issuing large amounts of bonds, whose higher yields could lure investors at the expense of equities.

On Thursday, this bundle of macroeconomic forces drove yields to the highest in decades. The 10-year US Treasury yield surged more than 10 basis points to 5.223%, the most in 19 years, while the 30-year yield hit 5.501%, the most since 2004. 

The Yield Appeal

This week offered new evidence that the US economy has the wherewithal to withstand higher interest rates, a key tool for the Federal Reserve to curb inflation. S&P Global released data showing US business activity surged at the fastest rate in more than five years in September. That strengthened the odds that the Fed will raise interest rates in October to about 70%, up from 55% a week ago, according to CME FedWatch.

Bond yields tend to track interest rates, and there are concerns about what a 5% or higher yield on the 10-Year Treasury means for markets. Because Treasurys are backed by the US government, they’re considered virtually risk free. When yields surge, investors are forced to rethink their rationale for choosing between stocks and bonds. Equities with 5% to 6% annual yields, which aren’t guaranteed and are subject to stock market volatility, are suddenly a lot less appealing to long-term investors who can lock in guaranteed returns through higher bond yields. The resulting concern is that investors are incentivized to move money into the Treasury market at the expense of stocks. In reality, it may not be so simple:

• Investment bank Jefferies forecasts earnings at S&P 500 companies will climb 35% this year. Growth like that is more than enough to keep investors from decamping for bond yields.
• For small-cap companies, which are sensitive to higher rates because they are much more reliant on short-term bank loans and floating-rate debt, the road ahead looks much steeper. 

Unlucky Number Seven: While the US economy remains resilient, there is one notable weak spot. The 10-year yield strongly influences consumer borrowing rates, and the average 30-year fixed mortgage rate rose to 7.03% on Thursday, the highest in 20 months, according to Freddie Mac data. The annualized pace of US home sales had already slowed for the past three months, and it’s hard to imagine people lining up for 7%+, 30-year mortgages.