How Low Can Bond Yields Go?

The Federal Reserve has finally opened the door for the 10-year Treasury yield to realign with several economic & market indicators which have long been suggesting much lower bond yields.

Since the consumer price inflation rate peaked at 9.1% in mid-2022, and despite subsequently declining significantly, the 10-year U.S. Treasury bond yield has nonetheless remained above 3% and mostly traded between 4% to 5%. Compared to several economic and financial market metrics, the 10-year Treasury yield has long appeared unresponsive. As real economic activity and inflation slowed further during the last few years, the Fed kept raising short-term interest rates and effectively put a floor under the 10-year bond yield. For example, at about 4% the 10-year yield is the same today as it was in September 2022 when annual nominal GDP growth was about 10% (which is now only 4.6%), when the CPI inflation rate was 8.2% (today it is only 2.9%), when U.S. commodity prices were 15% higher than today, and when annual U.S. job growth was almost 4% (compared to only 0.9% today). Now that the Federal Reserve finally announced it’s in easing mode, the question is how low can bond yields go?

What follows is a pictorial of various metrics (published in past missives) which have historically been closely aligned with the 10-year Treasury yield. Currently however, these economic metrics are disjoined suggesting bond yields may have much further downside potential than most currently anticipate. That is, since the Fed has finally opened the basement door, bond yields may finally be able to catch-up to economic fundamentals which have been weakening for some time.