March 6, 2023
The 10-year Treasury yield rose above 4% earlier this month, marking a fresh acceleration for a historic bond-market rout amid lingering inflation and fears of higher interest rates. This climb carried the key measure of borrowing costs back toward the decade-plus highs reached last year, and the recent leg was spurred by a run of strong economic data that dashed hopes inflation will rapidly slow to near the Federal Reserve’s 2% target. Rising yields lift borrowing costs for consumers and companies, and hurt the prices of other investments.
Last year, bets that inflation would rapidly decline stalled a year-long bond rout in November and powered a rebound in stocks. However, price pressures have lingered, pushing the Fed toward holding rates higher for longer than traders had expected. Investors spent much of 2022 wondering how high rates would eventually rise and how quickly, and in recent months, some of that uncertainty seemed to resolve as expectations crystallized around an eventual Fed rate target of roughly 5%, with some investors betting that a policy reversal—rate cuts—could follow later in 2023.
Now, that outlook is facing new tests. The Fed’s rate target, now at 4.5% to 4.75%, is approaching the 5% level that officials thought as recently as December would be high enough to control inflation. But the latest economic data have indicated that isn’t happening yet. The recent climb in yields has begun spilling over into other debt markets, such as the junk-bond market, lifting the yield offered by bonds rated below investment-grade, raising those companies’ borrowing expenses and threatening to undermine business conditions for weaker firms.
Additionally, the two-year Treasury yield, which is especially sensitive to Fed rate expectations, raced higher even faster than the 10-year yield. A situation in which short-term Treasuries offer higher yields than longer-term bonds is known on Wall Street as an inverted yield curve, which often signals to investors that a recession is on the way because they imply an expectation that the Fed will need to cut rates in the near future to cushion a slowing economy.
Some investors who believe that high interest rates will prove temporary have added to their holdings of Treasuries. However, market-based forecasts show that investors are still expecting the 12-month inflation rate to fall to close to 3% this year, from 6.4% in January. If it does, that would make real yields—the yields on government debt, adjusted for inflation—unsustainably high.
Overall, the recent surge in Treasury yields reflects a delicate balancing act for investors, who are trying to gauge how long inflation will remain elevated, whether the Fed will raise rates enough to combat it, and if stocks and other risk assets can weather the fallout. To know your options with your portfolio and how to make the most of 2023 opportunities, talk with a financial advisor today.