U.S. government-bond yields have staged a major rebound this month, reflecting increased optimism among investors about the near-term economic outlook.
Yields, which rise when bond prices fall, remain below their peaks set in June, when investors were most concerned about runaway inflation. But they are also now well above their recent lows, when analysts were hotly debating whether the U.S. was already in, or entering, a recession.
Investors mostly don’t think the U.S. is in a recession. Many still believe one is inevitable, as the Federal Reserve raises interest rates to bring down inflation. But many are now betting that it will take longer to get there, thanks to a run of mostly solid economic data and comments from Fed officials suggesting that they might start taking a more cautious approach to tightening monetary policy. Chairman
is due to speak Friday at the Kansas City Fed’s annual retreat in Jackson Hole, Wyo.
Not long ago, the narrative in the market was that the Fed was “sort of marching the U.S. economy over a cliff,” said
head of global G-10 FX research and North America macro strategy at Standard Chartered in New York. More recently, the feeling has been that “it may take a while yet for the economy to cry uncle.”
The yield on the 10-year U.S. Treasury note was 3.108% in recent trading, up from 2.605% on Aug. 1, according to Tradeweb. U.S. stock indexes were aiming Thursday for their second straight day of gains after three sessions of declines.
Yields on U.S. Treasurys largely reflect investors’ expectations for the course of short-term interest rates set by the Fed. They, in turn, set a floor on borrowing costs across the economy and—because Treasurys are nearly guaranteed to be paid back at maturity—establish a benchmark return against which other assets are measured.
Starting with a surprisingly strong jobs report in early August, good economic news has been bad for bonds in recent weeks because it has forced investors to extend the time-period in which they expect the Fed to raise rates. Just as important, investors have pushed off the date when they think the central bank will start cutting rates.
Notably, Treasurys haven’t really been helped by signs that year-over-year inflation might have peaked. The same is true for the slight shift in tone from Fed officials, who have recently acknowledged the risk of raising rates higher than is necessary.
In general, investors still see inflation as a threat given continued evidence of rapidly increasing wages, which are seen by many as a determining factor for consumer prices over the longer-term.
As a result, the good news on headline inflation and caution from Fed officials have, for investors, only lowered the chances that the central bank will raise rates so aggressively in the short term that they would have to start cutting them immediately.
Reflecting that assessment, yields on longer-term Treasurys have climbed faster than those on shorter-term notes in recent weeks—a departure from the trend for most of the year.
Since Aug. 9, the 10-year yield has narrowed its gap to the two-year note yield to minus 0.28 percentage point from minus 0.49 percentage point.
So far, U.S. stocks have held up reasonably well in the face of the latest jump in bond yields.
As was evident earlier in the year, rising yields can pose a particular threat to stocks of fast-growing companies that are valued largely for their more-distant earnings potential—those uncertain cash flows being worth less when investors can lock in a 3% return by buying a 10-year Treasury note.
As of Wednesday, the growth stock heavy Nasdaq Composite Index was up 0.5% from Aug. 1, when the 10-year yield fell to its recent low. It has, however, fallen 5.1% since Aug. 16, the day before the 10-year yield surged above 2.9%.
Investors at this point have differing views about where bond yields go from here—even in some cases where they share a comparable economic outlook.
Margaret Steinbach, a fixed-income investment director at Capital Group, said her firm’s core and core-plus bond funds have recently been positioned both for a general increase in yields and for a move higher in longer-term yields relative to shorter-term yields.
That bet, she said, is based on a belief that inflation is likely to stay elevated for longer than many investors think but that the Fed could raise rates “in fits and starts” as it shifts to a more data-dependent policy approach.
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John Flahive, head of fixed-income investments at BNY Mellon Wealth Management, similarly said that—contrary to what has been priced into futures markets—he doesn’t expect the Fed to cut rates in 2023 as inflation remains threatening.
He said he expects longer-term yields to drop even more below short-term yields—farther accentuating what is known on Wall Street as an inverted yield curve—as the Fed raises short-term rates from their current range of 2.25% to 2.50% to between 3.75% and 4%.
“I think inevitably central banks have to, and will continue to, fight inflation,” he said.
But, he added, that approach would only increase investors’ concerns about a recession, so that “the higher short-term interest rates go…the more inverted the curve gets.”
Write to Sam Goldfarb at email@example.com
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