Unpredictable 10-Year Treasury Yield Poses Puzzle for Investors, Fed
Recent declines in critical borrowing benchmark have come despite expectations for higher short-term interest rates
By Sam Goldfarb, The Wall Street Journal, Updated Dec. 13, 2022
Yields on longer-term Treasurys like the 10-year note play a critical role in the U.S. economy by setting a floor on borrowing costs for businesses and consumers…
If the Fed sends a so-called hawkish message, emphasizing concerns about inflation and projecting higher interest rates than expected, the 10-year yield could climb, as investors expect higher rates for longer. Then again, it could fall, if investors think that higher short-term rates alone could be enough to choke off the economy, forcing the Fed to quickly reverse course and start rapidly cutting rates next year…
Falling long-term bond yields are important in part because they could make it harder for the Fed to bring inflation back to its 2% annual target. Mr. Powell has pointed out repeatedly this year how investors’ rising expectations for short-term interest rates—as reflected in higher bond yields—have done more to fight inflation than the actual increases in the fed-funds rate…[end quote]
The market is showing a lot of confidence in the Fed’s ability to suppress inflation even if it means inducing a recession. The Treasury yield curve has been falling at the long maturity end while continuing to rise at the short maturity end. The 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity spread is -0.84%, the most negative on record.
The Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity is 3.61%. This compares with the 12-month CPI increase of 7.1% released yesterday. But the market’s ten-year inflation expectation is 2.45%. This would give the 10YT a real yield of 1.16% if inflation fell tomorrow. The 10-year TIPS is yielding 1.33% and falling.
As a result of falling long-term yields the 30 year mortgage rate is beginning to fall. This is good for the real estate market but it’s bad for the Fed’s efforts to reduce inflation.
The Fed could use QT (selling more long-term Treasuries and mortgage bonds from its bloated book than it announced) but they don’t like to deviate from their plan.
If inflation really does fall and the expected inflation is mild the falling 10YT yield makes sense. If inflation stays elevated and the economy slows – stagflation – the low 10YT yield will be a trap for bond traders as it has been before.