Today, 10-year treasury yields are close to breaking 4% and are approaching their 2008 highs.
Since collapsing at the height of the financial crisis, when investors sold everything just to own ‘safe-haven’ investments, U.S. 10-year treasury yields have now come nearly full circle, or shall we say full-V:
Government bond yields can go up for many reasons, both good and bad. Investors might think U.S. creditworthiness is deteriorating due to large amounts of debt, or they could believe that inflation is likely to pick up and thus need to be compensated.
At the same time, investors may demand higher yields from government debt if they expect higher interest rates from the Fed in the future, created by the Fed in response to a strengthening economy. They can also simply find other forms of investment more attractive, due to higher expected returns in alternatives like stocks. Thus we know U.S. government bond yields are rising, but the question is why.
Are rising bond yields are positive or negative sign? Should we be worried that bond markets are ready to take America to task for its debt? Or should we be happy to see bond markets signaling a rebounding economy?
Well today says it’s the latter, positive take on the bond market. Last Friday we had good news on the jobs front, we’ve recently had good news on the U.S. manufacturing front, and today we got good news on the U.S. services front. Bond yields have continued to surge. The yield curve has also steepened whereby the gap between short and long-term U.S. government debt has expanded.
Bond investors aren’t demanding higher yields because they fear inflation. You can easily check the bond market’s inflation expectations by examining the difference between inflation-linked and plain vanilla U.S. bonds. These inflation expectations remain muted, despite the recent government bond yield surge, at just 2.4% priced-in and expected U.S. inflation per year out to 2028 according to The Economist.
Bond traders don’t fear America’s creditworthiness either. Yields are rising on signs U.S. economic strength, such as is happening today. A stronger economy makes a country more creditworthy, thus you would expect bonds to rally (and their yield to fall) when good news comes out, if they are trading based on national creditworthiness.
Rather, bond yields are rising because decent U.S. economic growth has now become far more likely. As Scott Grannis, the retired Western Asset economist at the blog Calafia Beach Pundit, says, U.S. bond markets could now be pricing in about 2-2.5% U.S. GDP growth going forward. It isn’t mind-blowing growth, but it isn’t too bad considering where we have come from.
So bond yields are, yes, rising, but today shows that it is for the right reasons. They’re making a full-V, signaling a full-V for the broader economy as well.
But don’t miss: 11 signs of an imminent market reversal >
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