The recent surge in the 10-year Treasury yield, surpassing 4%, has caught the attention of market observers. However, according to Patrick Saner, head macro strategy at Swiss Re, this spike may mark the peak level for the benchmark rate in this particular cycle.
Saner believes that there is no need to panic, as the increase in long-term yields is not indicative of a looming bond crisis. Factors such as a significant influx of U.S. Treasury supply or concerns about creditworthiness after Fitch Ratings downgraded America’s credit rating to AA+ from AAA are not major driving forces behind the recent surge.
Instead, Saner’s team at Swiss Re attributes the rise in yields to inflation and its gradual retreat, as well as the resilience of the U.S. economy in the face of the Federal Reserve’s historic pace of rate hikes.
In a client note on Wednesday, Saner stated, “Our analysis shows that deficits, government bond supply, and country-specific monetary policies have had minimal impact on U.S. 10-year yields, at least for now.” He added that the market seems to be pricing in a higher “neutral” nominal policy rate across advanced economies, which has been the primary driver for the increase in yields.
The significance of the 10-year Treasury yield lies in its role as a key benchmark for pricing trillions of dollars in debt. From property loans sought by landlords to the financing needs of the government and major corporations, this rate plays a crucial role in determining borrowing costs across various sectors.
As we look ahead, Saner’s analysis suggests that the recent surge in the 10-year Treasury yield may prove to be a peak level for this particular cycle. The future trajectory of yields will likely depend on factors such as inflation trends and the overall strength of the U.S. economy amidst ongoing rate hikes by the Federal Reserve.
A Neutral U.S. Rate: What to Expect in the Coming Years
The concept of a “neutral” U.S. rate has become increasingly significant in recent years. This refers to the point at which the Federal Reserve’s short-term policy rate strikes the right balance for the economy, neither being overly restrictive nor overly accommodative. According to the Brookings Institution, this guidepost of monetary policy has been gradually declining since 1974, starting at 4%.
Looking ahead, Swiss Re predicts that the 10-year Treasury yield will reach 3.6% by the end of 2023, followed by a rate of 3.2% in 2024. Currently, the 10-year Treasury yield sits at 4.25%, near its highest levels since 2008, as reported by Dow Jones Market Data.
However, Saner’s team believes that further increases in the 10-year yield might be limited. This is due to the fact that much of the Fed’s tightening policy has already been implemented and the U.S. economy is expected to slow down in the latter half of the year.
That being said, if there is a sustained rise in wages and core inflation, along with an economic boost, Saner suggests that interest rates could see an uptick.
In terms of market performance, stocks showed mixed results on Wednesday after investors analyzed the minutes from the Fed’s July meeting. During that meeting, central bankers decided to maintain rates within a range of 5.25% to 5.5%, the highest level in 22 years.
At last check, the Dow Jones Industrial Average (DJIA) was up by 0.1%, the S&P 500 index (SPX) was down by 0.1%, and the Nasdaq Composite Index (COMP) was 0.3% lower, according to FactSet.
It is crucial for investors to closely monitor the unfolding of higher-for-longer U.S. rates, as concerns about rising yields continue to grow.