A dramatic surge in long-dated Treasury yields is primarily being driven by heightened real rates, reflecting a change in expectations for U.S. economic growth, according to Joseph Kalish, chief global macro strategist at Ned Davis Research. Kalish suggests that this single factor is responsible for a whopping 90% of the yield increase, highlighting that 5-, 7-, 10- and 20-year Treasury yields have all seen significant upticks since the 2021-2022 period. This comes as traders and investors increasingly factor in the prospects of a more robust U.S. economy in the coming years, a shift that is reflected in the upward trend of the 5-year Treasury yield, known as the belly of the Treasury curve.

In a departure from the norm, the current rise in Treasury yields is not being influenced by a variety of factors such as potential future inflation and investor demands for risk compensation. Instead, it’s the real rates, as indicated by yields on Treasury inflation-protected securities, that are in the driver’s seat. These rates offer a more unfiltered perspective on the performance of the U.S. economy, minus the effects of inflation. Presently, real yields are climbing on the back of promising economic data, fostering hopes among investors of a ‘soft landing’ – a scenario where inflation naturally eases without triggering a recession or a significant spike in unemployment.

Rise in Long-Dated Treasury Yields Linked to Higher Real Rates

The recent surge in long-dated Treasury yields is predominantly due to higher real rates, resulting from shifting expectations for U.S. economic growth, says Joseph Kalish, Chief Global Macro Strategist at Ned Davis Research. Making up 90% of the increase, this single factor has seen a notable rise in 5-, 7-, 10-, and 20-year Treasury yields since 2021-2022. On Tuesday, the 10-year rate closed at 4.327%, nearing its 16-year high. The 5-year Treasury yield, reflecting the intermediate part of the Treasury curve, has also trended upwards as traders and investors factor in a stronger U.S. economy beyond the next few years.

Changing Nature of Treasury Yields

Typically, Treasury yields rise due to a multitude of factors, such as the likelihood of future inflation and investors’ demand for risk compensation. However, the current scenario is slightly different. Real rates, represented by yields on Treasury inflation-protected securities, provide a clearer perspective on the U.S. economy’s performance, minus the inflation factor. Presently, real yields are rising due to strong recent economic data, with investors retaining some hope for a soft landing – a scenario where inflation drops naturally without inducing a recession or significant unemployment spike.

Rapid Rise in Bond Yields

"Bond yields have come a long way in a short period of time," noted Kalish in a Tuesday report. He pointed out that the primary cause for the rise is higher real yields, although the growing supply of U.S. government debt is also likely contributing. As of Monday, 10- and 30-year Treasury yields had respectively risen by 105.4 basis points and 91.7 basis points since early April, reaching their highest levels since November 2007 and April 2011. However, they dropped slightly on Tuesday to 4.327% and 4.410%, as traders and investors momentarily paused the aggressive sell-off of long-dated government debt seen over the past week.

Impact on Stock Market and Federal Reserve Expectations

The surge in Treasury yields is being held responsible for a pullback in the stock market, triggering a 4.4% retreat in the S&P 500 during August, albeit with a year-to-date gain of 14.3%. As the market eagerly anticipates Federal Reserve Chairman Jerome Powell’s Jackson Hole address on Friday, Kalish observed that the market has consistently underestimated the risk of additional rate hikes and overestimated the pace of rate cuts. According to Kalish, Powell will likely express satisfaction with the progress on goods inflation, optimism about the labor market’s balance, but concern about the economy growing faster than the trend.

Takeaways

The rise in long-dated Treasury yields reflects changing expectations for U.S. economic growth, underpinned by higher real rates. While the increase has put pressure on the stock market, it also signifies investor confidence in a resilient U.S. economy. The market’s anticipation of the Federal Reserve’s future actions further underscores the importance of monetary policy in influencing economic trends. As such, investors should closely monitor the interplay between economic growth, inflation, and government debt, to make informed decisions.