The prevailing theme in the market for some time has been “higher for longer,” suggesting that the Federal Reserve would maintain elevated interest rates over an extended period to combat inflation. However, an increase in long-term Treasury yields may be achieving some of the Fed’s goals and could potentially bring an end to the historic 19-month period of interest rate hikes reaches curbing inflation.
Steve Sosnick, Chief Strategist at Interactive Brokers, suggests that it’s no longer “higher for longer”; instead, it’s just “high for long.” The 10-year Treasury yields are on the verge of reaching 5%, a level not seen since 2007, preceding the global financial crisis. The 30-year fixed-rate mortgage is edging closer to 8%, a level last witnessed when the dot-com bubble burst in 2000.
Although rates may experience fluctuations, it is evident that we are undergoing a significant shift, according to Rob Almeida at MFS Investment Management. He believes it’s improbable for rates to return to the lows seen before the pandemic.
Several factors have contributed to the rapid rise in 10-year yields since last year when they hovered around 4%. Strong economic growth and persistent inflation tend to drive yields higher. The US Treasury has recently issued a substantial amount of government debt, and the prospect of costly conflicts in Ukraine and the Middle East could lead to further issuances. These factors push down bond prices and propel yields upward, making them attractive to buyers.
Regardless of the reasons behind this shift, an elevated 10-year Treasury yield translates to economic challenges for American consumers. This includes higher costs for car loans, credit card rates, and even student debt.
Moreover, it results in more expensive mortgage rates. Mortgage rates tend to follow the yield on 10-year US Treasuries. As Treasury yields increase, so do mortgage rates, and they typically decrease when Treasury yields fall.
However, what may be detrimental to the economy tends to be beneficial in terms of controlling prices. Federal Reserve officials, including Jerome Powell, have suggested that rates might be high enough to help bring down inflation to the target goal of 2%. Yet, they remain open to further rate hikes based on forthcoming economic data.
Fed Chair Jerome Powell highlighted the significant tightening of financial conditions in recent months, with long-term bond yields playing a crucial role in this process. He assured that the Fed would closely monitor these developments. Market sentiment supports this, with investors believing that Fed members will maintain interest rates at the central bank’s upcoming two-day policy meeting commencing on Halloween. The CME FedWatch Tool currently reaches a 99% likelihood that the Fed will continue its rate pause, up from 93% just a day earlier.
