For today at least, Treasury yields hint at a strong future economy
Sometimes the bond market gives us clues about the future economy. That is why we check on it from time to time. Recently, the yield on the 10-year Treasury note has moved up, and up and up. For a couple of weeks now, it’s been at around the highest level since late July.
The yield on the 10-year Treasury today is based on the economy of tomorrow, or at least what markets think the economy of tomorrow will be like. That is because a 10-year Treasury lasts for, you know, 10 years. And for most of this past summer, markets were bracing for a much slower economy ahead.
“A weakening labor market, having the unemployment rate rise and job growth really slowed down,” said Kathy Jones, chief fixed-income strategist for Charles Schwab & Co.
So markets thought, “Well, the economy of the future isn’t going to be that great, so I guess bond yields of today don’t need to be that great either.” And all summer long this mild gloom pulled 10-year yields down further and further, from 4.7% to 4%. But in September, the future changed.
“The jobs report, the unemployment report showed a pretty good gain,” Jones said.
Not only did the future look a little brighter, so did the past. The Bureau of Labor Statistics revised upward its estimates of job growth from months gone by.
“And when we got the revisions, I thought, ‘Oh well, maybe things are not that bad,” she said.
Plus, strong retail sales showed the consumer was just fine, and so the 10-year yield started moving back up because markets are now betting on a brighter future economy. Specifically, an economy that restrains any Federal Reserve plans to cut interest rates, said Steve Laipply, global cohead of fixed-income ETFs at BlackRock.
“If you look at what’s priced into the futures markets, we’ve taken out about two cuts,” Laipply said.
That means investors are now betting that the Fed won’t cut future interest rates quite as much as previously predicted. And so, if the rates of the future will be a little higher, the bond yields of today should also be a little higher.
But rising yields have another message baked in, explained James Camp, managing director of strategic income at Eagle Asset Management.
“About half of that is inflation expectations,” Camp said. “That 2% long-term inflation target in this type of economic reality may not be attainable.”
In other words, at least some of the bond market believes the inflation of the future will be slightly higher than the 2% annual rate the Fed considers ideal. Until, of course, the future changes all over again.