With the stock market closed for Labor Day, it might be a good time to take a look back at what’s happening with US government bonds.
There are usually two main drivers for bond yields, which move inversely to prices. One is short-term interest rates set by the Federal Reserve. Another downside is that inflation erodes interest-bearing securities. Those two are actually related, because the Fed is responsible for controlling inflation.
Since the Fed began raising interest rates from near zero to 5%, bond yields have risen sharply. In theory, borrowing government money for longer periods should yield higher rates or returns, so when short-term rates rise, long-term rates should rise more than short-term notes. That didn’t go as expected, but more on that later.
However, even before the Fed starts raising rates in March 2022, bond yields have been rising. In the year They were rising in 2021, when massive government stimulus ensured the economy was about to restart after the pandemic.
Indeed, the 10-year Treasury note in It is on track for a third straight losing year in 2023. Analysts at Bank of America September 1 suggested.
One oddity that has emerged over the past few years—the unexpected one mentioned above—is an inverted yield curve. The return on a 10-year bond is lower than the two-year interest rate. That reflects investors’ expectations that the Fed will raise rates in the short term to control inflation, and then start lowering them again.
An inverted curve is often considered a sign of recession, as the Fed usually cuts rates to support growth. But it is not necessarily a sign of recession.
Long-term interest rates appear to be falling without the aid of a sharp economic slowdown, suggesting the Fed will keep rates on hold for a longer period of time. The government’s announcement that it will increase the amount of debt auctions has also led to an increase in yields.
The yield on the 10-year Treasury note closed at 4.186% on Friday. It fell earlier on data showing a rise in unemployment, but rose after another report showed economic strength. In April, yields were as low as 3.3 percent, when the economic outlook looked less robust.
Whether yields continue to rise or whether 10-year bonds can reverse three years of declines depends, as always, on what the Fed does. But Gavecal Research analyst Tan Kai Xian says there are good reasons to think bonds will outperform stocks in the near term.
If rising unemployment is a sign of a weakening economy, investors may sell stocks because of declining company earnings. Similarly, if rising unemployment prompts the Fed to pay off, this is a boost to bonds. On the other hand, if the labor market continues to weaken without a recession, Treasuries may continue to underperform, he said.
“But history does not support such a soft landing scenario,” Xian wrote.
Bottom line: It’s very unusual for bond yields to rise or bond prices to fall — as long as they’re in a spell. Recent events have raised the bar even further. But if the Fed is close to ending its rate hike campaign, bonds should soon reverse their losing streak.
Write to Brian Swint at [email protected]
