What’s behind the rise in U.S. Treasury yields?
- The yield on the 10-year U.S. Treasury note surged to a 16-year high on 21 August
- Investor recalibration of the neutral rate may be pushing Treasury yields up
- European business activity is slowing, according to flash PMI readings for August
On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and ESG and Active Ownership Analyst Zoe Warganz discussed key drivers behind the increase in U.S. Treasury yields. They also reviewed what the latest global PMI (purchasing managers’ index) surveys suggest about the health of the global economy.
3 potential factors driving the jump in U.S. government bond yields
Warganz opened the discussion by noting that U.S. government bond yields have risen dramatically in the past few weeks, with the yield on the benchmark 10-year Treasury note topping 4.3% on 21 August. "This was the highest level since 2007," Eitelman remarked, noting that the sharpest rises in yields have occurred on the longer end of the Treasury yield curve. Short-term yields, he said, have remained fairly stable in August.
Eitelman stated that the selloff in Treasurys is not being driven by the latest U.S. inflation numbers, as recent reports have shown a marked deceleration in consumer-price increases. "If anything, it seems like realized inflation is tracking below the U.S. Federal Reserve (Fed)’s own forecast from back in June," he remarked.
In addition, the selloff probably can’t be attributed to any shift in market expectations over the path forward for interest rates, Eitelman said, noting that most investors continue to expect the Fed will opt to hold rates steady at its next meeting in September. Market pricing around the following Fed meeting in early November hasn’t changed much either, he said, with traders seeing a roughly 50-50 chance of a rate increase.So, what can the steep rise in yields be chalked up to? Eitelman stated he believes there are three factors at play. The first, he said, is that because the U.S. economy has so far proven to be a little more resilient than expected in today’s high-rate environment, some investors are recalibrating what the equilibrium, or neutral, rate of interest might be over the next five to 10 years.
Eitelman explained that the neutral rate is the rate at which monetary policy is neither speeding up nor slowing down the economy. "Recently, the market’s moved up the neutral rate to close to 4%, which is the highest it’s been in a very long time. I believe this is one factor pushing yields up," he stated.
The second potential driver is the increase in Treasury bill issuance, Eitelman said, which has changed the supply dynamics within U.S. government bond markets and surprised some investors. "Greater issuance could lead to demand for higher Treasury yields," he explained.
Last but not least, Eitelman said that some global factors could also be responsible for the uptick in Treasury yields. In particular, the Bank of Japan’s July 28 announcement that it will relax its yield-curve control on 10-year government bonds is likely playing a role, he noted. "For quite some time, Japan has been the anchor on global yields, helping to hold yields down. Now, the global anchor is lifting a bit, which could also be causing Treasury yields to rise," Eitelman remarked.
He said that for investors, a key takeaway amid the rise in yields is that fixed income looks like an increasingly attractive opportunity. "I think that Treasury yields of 4% or 5% constitute a pretty good hold-to-maturity return on safe government bonds," Eitelman stated, adding that if economic conditions deteriorate, Treasurys could potentially offer some capital appreciation potential as well.
What do the latest PMI surveys suggest about the European economy?
Shifting the conversation to economic data, Eitelman said that many flash – or preliminary – PMIs for August were released the week of 21 August. The PMI surveys provided some of the first reliable data points on the health of the global business cycle this month, he noted. Overall, Eitelman said the numbers suggest that business activity is gradually slowing down around the globe, with the exception of Japan, which was a standout to the upside.
"A slowly slowing economy was the key theme in our Q3 Global Market Outlook, and it looks like this is starting to come through in the data a bit," Eitelman remarked, adding that the slowdown is more pronounced in Europe. He explained that, like the U.S., the European region has battled high inflation by hiking rates into deeply restrictive territory. Similarly, European banks have also significantly tightened lending standards amid economic uncertainty, Eitelman said. One important point of distinction between the U.S. and Europe, though, is that in Europe, banks play a much bigger role in the real economy, he noted.
"This is probably one reason why we’re seeing the European region slow down a little sooner and maybe even a little bit faster than the U.S.," Eitelman concluded, stressing that the cooldown is mostly at the margins for now.