In a significant financial development, the yield on the 10-year Treasury has surged to 5% for the first time since 2007. This milestone holds implications far beyond Wall Street, affecting people worldwide.
Treasury yields have been on a rapid ascent, with the 10-year yield climbing from below 3.50% during the spring, and an astonishingly low 0.50% during the early days of the pandemic. As of Monday morning, the yield on the 10-year Treasury stands at 4.96%, briefly reaching 5.02%. This spike necessitates the U.S. government to pay more interest to borrow money from investors, leading to an increase in government spending.
The significance of this development reverberates globally, as the 10-year Treasury yield serves as the linchpin of the international financial system, influencing prices across various loans and investments. Beyond impacting the cost of mortgages for U.S. homebuyers, higher yields exert downward pressure on asset prices, spanning from stocks to cryptocurrencies, and may potentially result in increased layoffs within the corporate sector.
This shift to higher yields marks a stark departure from an era of persistently low interest rates, where central banks maintained benchmark interest rates at near-zero levels. These low rates facilitated borrowing, thus stimulating economic recovery following the 2008 financial crisis, the European debt crisis, and, most recently, the COVID-19 pandemic. While low rates led to surging prices in housing, stocks, and other assets, they might have also encouraged excessive risk-taking and speculative bubbles.
Central banks are now primarily focused on taming high inflation. To achieve this, they are raising interest rates with the aim of curtailing excessive spending.
The Federal Reserve’s primary interest rate pertains to extremely short-term loans, and it has already elevated its federal funds rate to the highest point since 2001, with further hikes under consideration. The intention is to maintain these higher rates for an extended period to combat inflation effectively.
The 10-year Treasury yield has been converging with the Federal Reserve’s main interest rate due to a series of reports indicating the continued resilience of the U.S. economy. While this mitigates concerns of a recession caused by high rates, it also keeps inflationary pressures and shorter-term rates on an upward trajectory.
Federal Reserve Chair Jerome Powell has suggested that various factors contribute to the rapid rise in the 10-year Treasury yield, such as the U.S. government’s significant deficits necessitating more borrowing and the Federal Reserve’s efforts to reduce its bond investments to keep yields low.
Additionally, the synchronicity between falling bond and stock prices is unsettling for investors who traditionally consider bonds a safer component of their portfolios. This trend has led them to demand higher yields for bond ownership.
The surge in the 10-year Treasury yield signifies increased borrowing costs for the U.S. government and subsequently impacts the interest rates for a wide array of loans. Even companies with top credit ratings have to pay more interest on their borrowings in addition to the U.S. government’s Treasury rates. Those with lower credit ratings face even higher interest costs, potentially constraining household spending and corporate expansion, ultimately affecting the broader U.S. economy.
Moreover, the 10-year Treasury, renowned as one of the safest global investments, wields substantial influence over the pricing of various other investments. When the Treasury offers significantly higher interest, investors find less incentive to invest in riskier assets like Big Tech stocks or cryptocurrencies. This phenomenon has played a significant role in the S&P 500’s year-to-date gains dropping from 19.5% in July to 10% as of the most recent data.
Higher U.S. yields attract more foreign investments, resulting in an increased demand for the U.S. dollar. Consequently, the U.S. dollar has strengthened by approximately 4% against the euro, 5% against the British pound, and 6% against the Australian dollar since the end of July. While a stronger dollar benefits U.S. tourists abroad, it can intensify financial pressures and inflation in other countries, particularly in the developing world.
Even U.S. bond investors are not immune to the swift rise in bond yields, as newer bonds offering higher yields diminish the appeal of existing, lower-yielding bonds in investors’ portfolios and mutual funds. The largest U.S. bond mutual fund is already grappling with a 3% loss in 2023, potentially marking its third consecutive annual loss, a phenomenon unseen since its inception in 1987.
