High Rates for an Extended Period?
The robust September employment report briefly pushed up long-term government bond yields, prompting investors to rethink their short-term expectations for interest rates. Since late June, the 10-year Treasury yield has risen from 3.8% to 4.8%, coming close to hitting approximately 5%, the highest level since June 2007. Over the past fifteen years, following the global financial crisis, the yield on the 10-year Treasury bond has ranged between 1.5% and 3.0%.
The initial phase of this rise in yields, as mentioned earlier, was driven by economic strength and the possibility of a soft-landing despite the Federal Reserve’s tightening policy. This contrasts with the predominant view earlier in the year, which anticipated a significant economic slowdown. However, as evident from the robust employment report for September, which saw the creation of 336,000 jobs (revised up from 227,000 in August), and an unchanged unemployment rate at 3.8%, this expected slowdown has not materialized. However, wage compensation increased at its slowest rate since mid-2021, at +4.2% annually.
On the other hand, the expectation of a prolonged period of higher federal funds rates, as revealed in the Federal Reserve’s September forecasts (5.1% by the end of 2024, up from 4.6% projected in June), coupled with rising oil prices, the Quantitative Tightening (the normalization of the Federal Reserve’s balance sheet), and the possibility of a further downgrade in the US credit rating, are among the factors contributing to this yield rebound. The next market-moving event will be the September inflation report, which is expected to show an annual rate of 3.6%, a slight deceleration compared to the previous month.
Given this complex mix of factors and variables, it’s not unreasonable to anticipate that we may continue to see elevated interest rates for an extended period. Some analysts even suggest that government bond yields could potentially range between 3% and 5%. The lower end of this range is considered plausible unless a severe recession materializes, a scenario not currently being factored in due to the robust labor market.
That being said, there still appear to be attractive entry points in the fixed-income market, particularly for investment-grade (IG) bonds (due to their lower correlation with the stock market) with maturities ranging between 5 and 10 years, where the spreads compared to US treasuries look enticing (credit premiums).
Historical yield on the 10-year Treasury bond.
Source: morningstar- Federal Reserve