Treasury yields have dominated recent conversation.
They’ve marched higher since early 2022, first in anticipation of the Federal Reserve’s rate-raising campaign, then during the campaign, and most recently on the following factors:
The Resilient US Economy: Despite higher interest rates, unemployment is low, GDP is growing, and consumers are spending. This successful soft landing by the Fed is good, but the economic strength could support higher interest rates for years. Therefore…
Higher Term Premiums: Investors expect new bonds to offer higher interest payments, and the expectation cheapens current Treasuries and drives up their yields.
Jim Caron, chief investment officer of the portfolio solutions group at Morgan Stanley Investment Management, explained to The Wall Street Journal in August:
“This massive [yield inversion, with shorter-term Treasuries yielding more than longer-term ones] that we’ve had for a long period of time was all predicated on the fact that you were going to get a hard landing and that owning long-duration bonds was the way to protect you. Now what the market’s saying is, well, if you’re not going to get a hard landing, then why would I want to own 10-year notes?”
The disinterest in 10-year notes accelerated in August to the point that, last week, yield on them breached 5% intraday, a 16-year high. (Weak demand for an asset reduces its price. When the price of a Treasury or any other bond falls, its yield rises. Thus a falling price equals a rising yield and vice versa.)
Accelerated is no overstatement, either. Peruse the following 2023 milestones on the 10-year Treasury yield’s mountain climb:
10-Yr Treasury Yield (%)
– – – – – – – – – – – – – – –
3.30 on Apr 6
4.05 on Aug 1
4.44 on Sep 22
4.98 on Oct 19
4.86 on Oct 23
It tap, tap, tapped at 5% last week, even on a closing basis, and poked above 5% intraday.
Bears say the rapid rise of Treasury yields means something will break. They remind everybody that, in fact, something already did break, back in March when the financial wizards running Silicon Valley Bank neglected to consider that their operation should probably be able to handle something other than near-zero rates, given that such rates existed only in an odd slice of history that happened to comprise the last decade and a half. But pride cometh before a fall, as does historical ignorance, so kaput went SVB and First Citizens Bank flew off with its carcass.
“See?” say bears. “More of that could lie in store.”
Well, it could, and goodness knows the economy has witnessed countless such washouts in what’s called a cycle for a reason, but we’re now seven months farther along in this cycle. Interest rates and bond yields have been climbing the whole time, and bankers adjusted. Instead of selling bonds to fund loans, they’re now borrowing from the Fed and other banks. It’s more expensive, but it works and, more important, the economy has spent more of its lifetime operating this way than the way it operated over the past decade and a half—the one that duped the dopes at SVB.
“Ah, ah, ah,” warn bears. “If banks now have to borrow more expensive money, it means businesses and consumers will need to pay more to borrow. That will slow the economy.”
Yeah, no kidding. It’s called financial tightening, and the Fed’s been pursuing it since March 2022 in a bid to dampen inflation.
So then, if Treasury yields have risen because of economic strength, shouldn’t it be good news?
Bears argued a year ago that the Fed’s rate-raising campaign would cause a hard landing, reducing stock-market earnings and causing a crash. The soft landing we’re getting instead should support earnings and therefore stocks, right? If so, what’s the problem?
An odd dynamic, evidently, something like this: Yields are up so far so fast on strong economic data that they might now crush the economy. Borrowing costs may have finally become expensive enough to slow down business and consumer spending. It’s been so good that it’s going to get bad.
If it spoke a normal language, the Fed would reiterate that this is the very point of restrictive policy as a means of reducing inflation. In its own way, the Fed has been saying this since early 2022, and there’s nothing controversial about it. All financial textbooks echo the idea. It’s how monetary policy works. Higher interest rates slow down economic activity, which lessens demand for goods and services, enabling their prices to fall.
Bears grin slyly. “And that’s the hard landing we’ve been warning about.”
Sort of, but they never mentioned that their hard landing would be caused by the soft landing they swore to be impossible. Seems to me a rather key revision in hindsight.
To keep this soft/hard uncertainty consistent with financial forecasting’s reputation for being a moving target on a shifting field on a cloudy day, a hard enough landing could cause the Fed to reverse its higher-for-longer plan for interest rates, stop its tightening, and get stimulative again. Yields rise, the economy cracks, unemployment skyrockets, but inflation reaches the Fed’s 2% target, so the central bank declares victory and starts sweeping the ashes into something resembling a phoenix.
This used to be called a cycle. Now it’s called armageddon.
Since we can’t know whether the soft landing will lead to a hard landing, or whether the hard landing will lead to a soft recovery, we may have to focus on hard inflation’s drop to softness.
The bogeyman has been high inflation for going on three years. First the Fed called it transitory, blaming pandemic supply chain shutdowns, then it panicked and called reducing it the number one priority on the spreadsheet, and lit a rocket under the fed funds rate. “More work to do,” they intoned, by which central banksters mean adjusting their interest rate (fine work if you can get it), and lit more rockets until we went into this acceleration everybody’s talking about.
Funny thing about it, though, is that the 10-year Treasury accelerated merely to its historically normal range. Heads-up, kids: 5% ain’t high, historically speaking. If one’s history begins with Facebook’s 2004 inception, then sure, 5% looks stratospheric. But to real history it’s the norm, making the recent acceleration to it akin to watching a stoplight turn green and getting the car up to … 35 mph. Not much of an adrenaline jolt.
No matter, and no need to tell the people who spent their lives at the stoplight that this ludicrous speed of 35 mph is normal, sit back and relax. It’s more fun to freak them out, which is pretty much mainstream media’s business model.
A current version of the freakout goes like this:
The soft landing leading to a hard landing will cause a recession. Stop cheering the resultant drop in inflation, despite it having been the goal. This is no mission accomplished, it’s a pivot to purgatory. What comes next is an overshoot in the inflation decline, killing the money supply, crashing interest rates and dumping the dollar. Don’t tell former SVB management or they’ll form a new bank. Forget “higher for longer,” the Fed’s momentary idea for interest-rate bumper stickers suitable as stocking stuffers. It’s about to trade inflation panic for deflation panic, slash rates, and print money again. You know, the good ol’ days of … 2020.
That’s the science of monetary policy, as conducted by two-handed economists.
Transitory inflation begets panic attacks about runaway inflation. Interest rates go from zero to normal in record time. Nobody notices the normal part. A hard landing is inevitable—no, wait—avoided entirely, as interest rates decline, as intended. The soft landing is great, except that it foments a hard landing alongside the benign inflation readings. Success against inflation conjures the nightmare of deflation, turning a strong dollar weak, and making business loans, mortgages, and credit cards more affordable. This releases animal spirits that cause a spending binge and levitate stocks into another bubble.
It’s enough to make a student of economic and stock market history look up and say, “Wait a minute. We’ve seen this before. They used to call it a cycle, and through its repeating decades stocks have risen twice as often as they’ve fallen, and real estate has been a fabulous investment.”
Maybe we should just stick with price reaction after all.