On Wednesday morning, the yield on the benchmark 10-year Treasury note moved back over 3%. In just the past five years, though, that has only happened twice before, but then only for a day or so. Is this the time the yield breaks 3% and stays there?
The most recent time before Wednesday, of course, was just two weeks ago. On April 24 the yield moved a hair above 3.0%%, then hit 3.03% the next day. It then quickly retreated below the magic number and hasn’t gone above it until now.
Before then, the last time the yield hit 3% – and I mean just – was at the very end of 2013 and the very beginning of 2014. It hovered right at 3% for a few days and then subsequently dropped sharply, eventually falling to well below 2.0% over the next year. The last time the note has been comfortably over 3% and remained there, was back in the summer of 2011.
What is it about that 3% mark that fixates investors – or rather, attracts them? Just like in 2013, that 3% figure seems to serve as a buy signal for investors.
Are they making a mistake? Is it really a buying opportunity, or just a bond market head fake?
In fact, the economic indicators – and signals from the Federal Reserve – argue strongly for much higher bond yields.
The core personal consumption expenditures index, the Fed’s primary inflation indicator, rose 0.2% in March compared to the previous month and 1.9% versus a year ago. Not exactly hitting the Fed’s 2% target inflation rate, but close enough. The core consumer price index did go above that figure, climbing 2.1% on an annualized basis, while the core producer price index jumped 2.7% compared to a year earlier.
Granted, economic growth did slow in the first quarter, but not a whole lot and still strong compared to its recent performance over the past few years. GDP grew at an annual rate of 2.3%, down from 2.9% in the fourth quarter of last year but the strongest first quarter in three years. GDP growth has now grown by more than 2% for four straight quarters. The Institute for Supply Management’s two indexes both continued a recent downtrend, falling for the third month in a row in April. But let’s not forget that both of them are coming off multiyear highs, and are nowhere close to contraction territory.
Last Friday’s jobs report was a little weaker than expected but probably strong enough for the Fed to keep raising interest rates this year, as it indicated after last week’s meeting, even before the jobs number came out. “The committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate,” the Fed said. That makes a rate hike at next month’s meeting close to a near lock. I wouldn’t be surprised if two more – not just one – will happen later this year, making it four for 2018.
While all of this has been going on, the paint has been drying in the Fed’s massive bond portfolio, but that doesn’t mean we should take our eye off it.
As of May 2, the Fed’s balance sheet stood at $4.356 trillion. That’s down from the peak of about $4.5 trillion reached about two years ago. So the portfolio has been trimmed by a mere $150 billion. That’s a rounding error, agreed, but it’s also taking place at the same time the Treasury’s debt sales plans are skyrocketing as the federal budget closes in on $21 trillion.
Last week Treasury said it plans to sell $73 billion of debt this quarter, raising the auction sizes of both the coupon and floating-rate debt again for the second straight quarter for the first time since 2009. It’s even adding a new two-month bill to the menu. And the Fed won’t be there as a buyer.
Given these factors, it’s hard to see how long-term bond yields can continue to stay under or around 3%.
Now, it’s mighty difficult to predict bond yields looking solely at the federal debt load and the government’s borrowing needs. Other factors play into it – investor demand, for example, which could grow stronger if the stock market and world events remain volatile. A 3% yield on 10-year government-guaranteed debt looks pretty attractive, especially when the yield on the S&P 500 – which is down 10% off its record high – is now well under 2%.
We also have oil prices hitting $70 a barrel, which is pushing gasoline prices past $3.00 a gallon as we enter summer driving season. Possible increased tensions in the Middle East won’t help.
Can lower bond yields coexist in this environment? Maybe, but only if the economy were to fall into recession, a prospect I find a bit far-fetched.
The current recovery is one of the longest on record. But it’s also the weakest. Speaking for myself, and probably millions of others, the recovery only really kicked in about a year and a half ago, not ten years ago. The economy has many more years of expansion in front of it, which means bond yields have nowhere else to go but up.
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George Yacik
INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
