US Treasury 10-year yield breaches 5% for first time since 2007

SYDNEY – The US 10-year Treasury yield crossed 5 per cent for the first time in 16 years, propelled by expectations that the Federal Reserve will maintain elevated interest rates and that the government will further boost bond sales to cover widening deficits.

The yield rose as much as 11 basis points to 5.02 per cent, the highest since 2007. Fed chairman Jerome Powell suggested last week that central bankers are inclined to hold rates steady at their November meeting, but remain open to hiking again if a resilient economy fans inflation risks.

Meanwhile, bond investors are being asked to buy increasing quantities of Treasury notes and bonds. The US budget deficit has grown, in part because of rising interest costs. At the same time, the Fed is not replacing all of the Treasuries on its balance sheet as they mature. Dealers estimate that the outstanding debt will increase by US$1.5 trillion (S$2.05 trillion) to US$2 trillion in 2024, versus about US$1 trillion in 2023.

“Yields are rising because we are finally seeing supply come in,” Mr Tom Tzitzouris, head of fixed-income research at Strategas Research Partners, said on Bloomberg Television on Monday. Fed rate increases and balance sheet reduction are “catching up with the bond market now”.

The US Treasury increased the size of its quarterly bond sales for the first time in 2½ years in August, and Secretary Janet Yellen’s department is now readying its November financing plans.

Yields have not been this high since the era that preceded the Fed’s experiment with unconventional policies – near-zero benchmark rates and quantitative easing – aimed at shoring up an economy that had been rocked by the sub-prime mortgage crisis and collapse of Lehman Brothers. Those policies were implemented on and off for 15 years until the Covid-19 pandemic, and the wave of government spending it triggered fuelled an inflation surge that forced policymakers to raise interest rates closer to the norm seen for decades.

The Treasury market is the world’s biggest bond market, and Treasury yields are considered risk-free rates of return for the purposes of comparison with other investment opportunities. The rise in yields translates into higher borrowing costs for households, businesses and governments in the United States and abroad. Stocks retreated worldwide on Monday.

The rise in yields has humbled the giants of the financial world, some of whom predicted that 2023 would prove to be the “year of the bond”. The 10-year yield began this year at around 3.9 per cent, and most Wall Street firms expected that it would decline as the Fed rate increases that began in March 2022 took their toll on the economy and brought inflation to heel. Among major dealers, Goldman Sachs had the most bearish forecast, calling for a year-end level of 4.3 per cent.

More recently, disdain for bonds has been powerful enough to offset haven flows into US debt as the Israel-Hamas conflict reignited geopolitical worries.

The rout has dragged yields in Europe higher too. The yield on German and British 10-year bonds jumped 8 basis points on Monday, back towards multi-year highs.

The sell-off over the past two months has been driven by long-dated bonds, which are more vulnerable to an extended period of elevated rates and robust growth. US consumer prices advanced at a brisk pace for a second month in September and economic data continues to point to a resilient economy.

“While levels look attractive in the near term, investors are likely to continue waiting for catalysts (such as geopolitical risks or slowing data) rather than catching the falling knife amid technical weakness,” TD Securities strategists wrote in a recent note. “This could keep rate volatility extremely high in the near term.”

In the longer term, rates may be pushed above the levels of recent history. A new Bloomberg Economics report concludes that the combined impact of persistently high levels of government borrowing, more spending to fight climate change and faster growth will mean a nominal 10-year bond yield in the region of 6 per cent.

In the immediate future, the Treasury market remains on course for an unprecedented third year of annual losses.

Higher borrowing costs may ultimately serve as a brake on the US economy, helping the Fed’s inflation fight. The average rate on a 30-year fixed mortgage has soared to around 8 per cent in recent weeks, while the cost of servicing credit card bills, student loans and other debts has also climbed as market rates rise.

Mr Powell echoed some of his colleagues by saying that a sustained rise in yields could “at the margin” lessen the pressure for tighter monetary policy. Bloomberg Economics reckons that if the recent increase is sustained, it is the equivalent of about 50 basis points of Fed tightening. BLOOMBERG