There goes the swagger. Sure, the bond market’s attitude (or was it misplaced nonchalance?) of late has evaporated amid the roar of selling the benchmark 10-year Treasury Note in recent days. As such, the yield on the 10-year jumped to as high as 4.78% at one point yesterday, up from around 4.50% at the end of February.
Yesterday’s closing yield was the highest in nearly two years for the 10-year Note. What’s up? The economy, one could argue. A number of reports of late leave the impression that economic growth remains sufficiently potent to keep the Federal Reserve on track for raising short-term interest rates. To be sure, the Fed’s been doing just that for almost two years, and the bond market has more or less yawned. Why is the fixed-income set taking note now?
Good question, and there’s any number of theories about what constitutes an answer. That starts with some who argue that it’s the renewed fear of higher inflation down the road that’s caught the bond market’s notice. Perhaps, although the hard evidence remains a gray area at the moment. Inflation may present an approaching challenge to fixed nominal yields, but the statistics don’t yet confirm such fears. And as of this morning, at least, the 10-year yield has slipped a bit, offering some hope that the bull market that some in bond land expect even at this late date is intact.
So, how to square that with the realization that the string of economic reports over the past two weeks has shown a bias, though not exclusively, toward the forces of growth? Is the bond market reacting to the revised thinking that the formerly anticipated letup in the Fed’s tightening will be postponed? More than a few pundits have noted that the prospect of a 5% Fed funds rate in the coming months doesn’t sit well when then 10-year bond yield isn’t much higher.
The debate over a flat and/or inverted yield curve has been topical of late, but until recently the bond market has only talked about it rather than acted. But that’s changing, or so one could argue. How long it lasts is an open question, but for the moment the fixed-income market is inclined to demand higher yields.
A similar outlook prevails in the trading pits of Fed funds futures. The July contract is currently priced for 5.0%, or 50 basis points above current Fed funds.
But for all the talk of economics and statistics, the bond market is susceptible to emotion as well as numbers. Fear and greed, in other words, play a role, in degrees that vary with the news du jour. Fear and greed, of course, aren’t easily modeled in spreadsheets. Nonetheless, fear may be in a bull market again, its current form coming by way of the “harm and pain” rhetoric, which Iran has reportedly announced as what awaits the United States in response to Washington’s campaign of “hauling Tehran before the U.N. Security Council over its nuclear program,” to quote today’s Guardian.
The appropriate yield on a 10-year Treasury is the great question in finance of late. Traders have recently decided that higher is better. Figuring out what’s driving that decision is never easy, but rarely has it been as tough as it is right now. Perhaps that’s the key reason that the bond market prefers to err on the side of higher rates. Such thinking doesn’t lend itself to quantitative modeling, but investors still understand the reasoning.