Bond Yields are Too HIGH!

The almost 1% increase in the 10-year yield since mid-September should begin moderating U.S. economic momentum by late December allowing a renewed bond market rally in the New Year!

Bond yields have taken center stage in the financial markets.   The 10-year Treasury bond yield has surged from a low of 3.6% on September 16^th to an intraday high briefly last Friday above 4.5%!  The nearly 1% rise in just two months is due to a variety of reasons.  

First is the Trump trade.  Leading up to the Presidential election, a consensus developed that a Trump win would mean higher bond yields as his agenda advocated juicing economic growth with fiscal spending and tax cuts.   As the political presidential betting markets rose expecting a Trump win, bond yields also rose and have continued higher since Trump won the White House.

Second is a growing obsession with a rising Federal deficit, debt, and interest burden.  Large peace time deficits since the pandemic have produced a troublesome Federal government debt service burden raising investor anxieties that bond vigilantes may ultimately impose fiscal discipline by simply refusing to buy bonds and forcing yields higher.    

Third, the recently announced Federal Reserve’s easing campaign is now proving wishy-washy and uncertain as Fed members increasingly are recanting on how fast they may cut the Funds rate.   This has forced bond investors to also alter their yield expectations.

Fourth, until very recently, a persistently strong stock market has been unfazed by surging bond yields.  Often, upward trending yield markets keep rising until something breaks – usually until the stock market succumbs.  

Fifth, inflation concerns are again rising.   Most inflation reports remain tame and hardly alarming.  For example, the Bloomberg U.S. commodity price index has declined by about 6% from its recent high at the start of October and remains almost 30% below its post-pandemic peak in mid-2022.  The CPI inflation rate has risen mildly to 2.6% from its post-pandemic low of 2.4%, the PPI inflation rate is just 2.4%, and the overall U.S. wage tracker is currently at its post-pandemic low of 4.6%. Current inflation reports overall remain docile, but inflation expectations (fears?) have nonetheless recently increased slightly.   The 10-year U.S. breakeven rate (the 10-year forward inflation expectation of the bond market) has risen from 2.03% in mid-September back to where it last was in early June at 2.38%. 

Although these factors have contributed to the recent surge in bond yields, in my view, they have played only a minor role.   While I may be wrong, these seem like explanations offered whenever yields rise rather than major contributors to the real reason why yields have increased.   I think there is an overwhelming culprit behind the recent rise in bond yields and that is simply improving economic momentum.   Yields should keep rising as long as economic activity proves stronger than expected.  But when economic momentum again moderates, yields will likely decline and all the “reasons” for rising yields should quickly disappear.