The rapid ascent of US government bond yields has left investors both amazed and cautious, with historical precedent and a rapidly changing economic landscape contributing to the uncertainty. The 10-year Treasury yield, a critical benchmark for the cost of borrowing throughout the financial system, has surged by over four percentage points in the past three years, reaching 5% for the first time since 2007. This climb is reminiscent of the early 1980s when the 10-year yield reached nearly 16% as the Federal Reserve, under Paul Volcker, aimed to combat inflation.
While similarities exist, it’s important to recognize the differences. In the 1980s, the aggressive monetary policy measures led to two recessions. However, today, the US economy has defied pessimistic forecasts and continued to grow, with the Atlanta Fed’s estimate suggesting that it gained momentum in the third quarter.
One factor differentiating the two eras is that policy was much more restrictive during the Volcker era. When adjusted for inflation, the “real” 10-year Treasury yield was around 4% by the time the second downturn began in 1981, compared to around 1% today.
Nonetheless, the remarkable strength of the US economy has injected considerable uncertainty into the markets. Bond yields have surged over the past few months as the Federal Reserve, under Chair Jerome Powell, has embarked on aggressive interest-rate hikes. While this strength has been consistent, it remains to be seen whether it can be sustained.
Billionaire investor Bill Ackman recently closed his bearish bets against long-term bonds, citing a fast-approaching economic slowdown. The year began with similar predictions, accompanied by expectations of a bond market rally as the Fed shifted course. Instead, bond prices have continued to decline. The Bloomberg US Treasury Total Index is down approximately 2.6% this year, extending losses to 18% since its peak in August 2020, a more painful selloff than previous periods, particularly due to the historically low rates that suppressed income payments.
Another contributing factor is the surge in the federal deficit, flooding the market with new Treasuries at a time when major central banks, including the Fed, have scaled back their bond purchases. This dynamic has pushed yields higher in recent weeks, even as the futures market suggests traders believe the Fed’s rate hikes are nearing their end.
In the midst of these economic dynamics, investors remain cautious. There is an underlying uncertainty, and predictions of a potential “hard landing” are being made, although leading indicators of a recession remain unclear. Conviction levels among investors are low, and many who had been buying bonds have faced losses in the current market environment. The interplay between economic resilience and market uncertainty is a complex narrative that continues to unfold.
