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The 10-Year Treasury Yield Surged To A 16-Year High: Here’s Why


The 10-year Treasury yield hit a 16-year high early Monday, taking the wind out of an S&P 500 rally attempt. Stronger-than-expected manufacturing and construction data as well as the weekend deal to avoid a government shutdown gave a big boost to odds of another Federal Reserve rate hike.


10-Year Treasury Yield Rises As Inflation Falls

The continued move higher for the 10-year Treasury yield comes despite Friday’s largely benign inflation report, which continued the recent disinflationary trend. The Fed’s key measure of core inflation rose just 0.1% in August, the smallest monthly gain since late 2020.

The 10-year Treasury yield rose as high as 4.71% early Monday before easing to 4.67%. The 10-year yield had fallen as low 4.5% on Friday morning, before bouncing to 4.57% to end the week.

While Fed Chair Jerome Powell has said the central bank will need to see six months of tame data to gain confidence in the current trend, we’re getting pretty close. The six-month annualized core PCE inflation rate eased to 2.9% in August from 3.4% in July.

Real Interest Rates Rise

So if inflation is falling, why are the 10-year Treasury yield and other government bond yields moving higher? The reason is that real interest rates, which subtract inflation, are rising. That’s in part because the Fed thinks it will take higher real interest rates, at least temporarily, to wrestle inflation back to 2%.

New projections released last month showed the Fed key policy rate ending 2024 at 5.125%, even as core inflation recedes to 2.6%. That implies a 2.5% real interest rate. Over the past decade, by comparison, the Fed has assumed the neutral real interest rate, at which monetary policy is neither accelerating or diminishing growth, was just 0.5%.

Why might the neutral rate be higher? Onshoring of manufacturing and deglobalization, the cost of the transition to renewable energy, and aging demographics that contribute to a tighter labor force are some of the reasons.

Still, the Fed could be wrong. Consumers and small businesses might succumb to high interest rates before the Fed expects. High interest rates, high gas prices and renewed student loan payments are all hitting consumers at the same time. The Fed’s projections are based on what was happening in the economy in June and July, before those recent stresses escalated.

ISM, Construction Spending

Until incoming data shows consumption flagging and the job market rolling over, there may not be much relief from high Treasury yields. We certainly didn’t get that kind of data on Monday.

The Institute for Supply Management’s manufacturing index exceeded expectations, rising 1.4 points to 49. Production rose 2.5 points to 52.5, signaling a return to growth after a neutral 50 reading in August. The new order index rose to 49.2 from 46.8. The indicates orders, though still declining, have largely stabilized.

The ISM employment index rose to 51.2 from 48.5, indicating net hiring last month. That’s consistent with expectations for a solid jobs report on Friday.

Construction spending in August rose to a $1.9385 trillion annual rate, up 0.5% from July, as expected. However, spending rose a stronger-than-expected 7.4% from a year ago because July’s monthly gain was revised up to 1.2% from the initially reported 0.7%.

The manufacturing construction boom continued, as spending on this category rose to $198.4 billion, up 1.2% on the month and 65.5% from a year ago.

Treasury Supply

Another factor keeping upward pressure on Treasury yields has been a surge in supply. The Treasury’s needs have been rising partly because of growing deficits and partly because the Treasury had depleted its cash reserves held at the Fed before the debt limit was lifted by Congress in early June.

On July 31, the Treasury raised its Q3 borrowing plan to $1.01 trillion, up $274 million from the preliminary number announced in May. At the same time, the Treasury said it expected to borrow $852 billion in Q4. Even at the Q4 pace, that’s a $3.4 trillion annual rate, which is way above the expected $2 trillion deficit.

One more factor contributing to excess supply is the Fed’s quantitative tightening program, which is unloading up to $95 billion per month in Treasuries and government-backed mortgage securities.

Fed Rate-Hike Odds

Odds of a quarter-point rate hike on Nov. 1, when the Fed’s next policy update is due, jumped to 26% on Monday from 18% on Friday, according to CME Group. Odds of a hike by the Dec. 13 update rose to 45% from 35%.

Stronger economic data and the federal government averting a government shutdown are reasons for the higher Fed rate-hike odds.

S&P 500

The S&P 500 fell 0.6% in Monday afternoon stock market action. The S&P 500 had notched a slight gain early Monday, but ran into a buzz saw as the 10-year Treasury yield climbed.

After Friday’s benign inflation data, it looked like the S&P 500 might string together a third straight gain. But stocks reversed lower on Friday, and the near-term outlook looks poor.

Be sure to read IBD’s The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.


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