BOND YIELDS HITS HIGHEST SINCE 2008, ADDING PRESSURE TO BORROWING COSTS / THE WALL STREET JOURNAL

Bond Yield Hits Highest Since 2008, Adding Pressure to Borrowing Costs

Bets that interest rates will fall have suppressed 10-year yields for most of 2023, but analysts warn that may be changing

By Sam Goldfarb

The yield on the 10-year U.S. Treasury note hit a 15-year high, threatening steeper costs for many borrowers and raising concern on Wall Street about the potential fallout in the stock, bond and housing markets.

A key benchmark for interest rates across the economy, the 10-year yield settled at 4.258%, according to Tradeweb. 

That was up from 4.220% Tuesday and marked its highest close since June 2008, months before the collapse of Lehman Brothers and expansive Federal Reserve policy ushered in more than a decade of historically low bond yields.  

The rise in yields is making investors nervous, because past surges have at times proved destabilizing for markets. 

With the 10-year yield still well below the level of short-term interest rates set by the Fed, some analysts see ample room for it to keep climbing—a development that could lead to unexpected disruptions, as investors are forced to unwind wagers based on projections for lower yields.

U.S. stocks fell Wednesday, with the Dow Jones Industrial Average dropping roughly 181 points, or 0.5%.

When investors start demanding higher yields on longer-term bonds to compensate for the risk of inflation, that “is correlated with lower risk-asset prices,” said Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management. 

“I think that’s what markets are worried about right now.”

The 10-year yield has been climbing for weeks based largely on a run of solid economic data, which has prompted many investors to abandon bets that the U.S. is headed toward a recession over the next six to 12 months. 

Higher yields mean lower bond prices.

Longer-term yields got an extra boost this month when the Treasury Department announced that it would need to borrow more than anticipated in the coming months to finance the federal budget deficit. 

That is forcing investors to buy more bonds than they might have wanted. 

Long-term bond yields largely reflect investors’ expectations for what short-term rates set by the Fed will average over the life of a bond, though they can also be affected by other factors, such as investor sentiment about the health of markets and the global economy. 

The new milestone for the 10-year yield is a stark reminder of how much the economy has changed since the start of the Covid-19 pandemic.

The Federal Reserve last month raised interest rates to a 22-year high. PHOTO: PATRICK SEMANSKY/ASSOCIATED PRESS

For years, developed economies across the globe appeared stuck in a perpetual state of sluggish growth, tepid inflation and ultralow interest rates, which even experiments with deficit-financed tax cuts or spending programs did little to change. 

Now, central banks are working hard to tame inflation, short-term rates are at their highest levels in decades and the U.S. economy, in particular, is barely slowing down. U.S. stock indexes have risen significantly this year. 

“We’re in a different world,” said Leah Traub, a fixed-income portfolio manager at Lord Abbett.

The main difference, she said, is that inflation remains comfortably above the Fed’s 2% target, which will make the central bank reluctant to cut interest rates even if the economy does start to falter.

In fact, inflation—which surged in 2021, driving the Fed to embark on a historic series of interest-rate increases in 2022—has shown some signs of cooling in recent months.

That has made the recent jump in yields particularly noteworthy. 

Instead of betting that the Fed will have to raise interest rates ever higher to defeat inflation and then start cutting them once a recession arrives, investors are wagering that the Fed may be done raising rates but also further away from any cuts.

That has helped drive up longer-term bond yields relative to shorter-term ones, in a reversal of the dominant trend over the past year-and-a-half. 

Minutes of the Fed’s most recent policy meeting released Wednesday afternoon added to recent signs that officials are growing more cautious about raising rates.

Higher yields have wide-ranging consequences for financial markets and the economy.

Though they don’t have to hurt stocks if investors are simultaneously lifting their outlook for corporate profits, they can reduce the appeal of riskier assets by offering investors a more attractive risk-free return if they hold Treasurys to maturity.

For many, the most important fallout will be the impact on mortgage rates, which are closely linked to the 10-year yield.

An extended period of higher bond yields would be a disappointment for recent home buyers who have been rooting for rates to fall so that they can refinance their mortgages, along with others waiting to buy a home. 

The average rate on the standard 30-year fixed mortgage has climbed to 6.96%, up from about 5% a year ago.

Looking ahead, many investors say that the Kansas City Fed’s annual symposium in Jackson Hole, Wyo., later this month could mark an important moment for the bond market, particularly since the central bank has said that the theme of the meeting will be “structural shifts in the global economy.”

That has led to speculation among investors that officials and economists could discuss not just where rates need to go in the short-term but where they might settle over the longer-term. 

That somewhat theoretical exercise could nonetheless help drive the 10-year yield even higher, some investors say.

Others, though, still don’t buy the increasingly popular argument that there have been fundamental changes to the economy that will prevent interest rates from falling back to their prepandemic levels, when the 10-year Treasury yield averaged about 2%.  

“I do think we’re seeing a little bit more resilience in the economy, but it doesn’t really change what I would see as sort of the medium-term risks to the economy,” said David Kelly, chief global strategist at J.P. Morgan Asset Management.

The unemployment rate, he added, is unsustainably low, putting the economy at high risk of a recession.

The 10-year yield, notably, has climbed above 4% other times over the past year only to fall back below 3.5% in relatively short order.

Bond yields, and markets generally, will continue to be heavily influenced by inflation data.

“If we get a really hot inflation print one of these months, that changes everything,” said Matthew Tuttle, chief executive of Tuttle Capital Management.