The yield on the 10-year US Treasury spiked above 2.6% overnight on Thursday, taking it to a level not seen since March of last year. This is just the latest in a series of moves higher Treasury yields have made since bottoming at 2.03% at the beginning of September.
What happens next will be critical for both Fed policy and stocks. The concern is that yields will continue to push higher, forcing the Fed to raise interest rates more aggressively, which could slow the economy and make it more expensive for people and businesses to get loans.
Two of the bond markets most prominent personalities have already urged caution. Bill Gross, the manager of the Janus Henderson Global Unconstrained Bond, wrote earlier this month that “tax cuts and increasing budget deficits” will boost inflation and to this end, he’s betting against bonds as he thinks the long-awaited bond bear market has begun.
This view has been echoed by Jeffrey Gundlach, chief executive of DoubleLine Capital. During October of last year, Gundlach told Bloomberg that the 10-year yield would move toward 3%, which if reached in 2017 would end the bond bull market. If this did occur, Gundlach was forecasting a yield of 6% by 2020. The 10-year is still far away from the fundamental 3% level, but Gundlach is holding fast. He reportedly told investors earlier this year that bond yields will start to spike later in 2018 spooking investors. As this unfolds, he believes the S&P 500 will end the year in the red.
10-Year Yield: Not what it used to be
Economists at Capital Economics think that these forecasts predicting a bond bear market have little substance. In a research note set out to clients today, CapEcon’s Chief Markets Economist John Higgins writes “One reason is that a lot of the decline in the 10-year yield over the past three decades reflects structural changes in the economy.” Therefore, there’s no reason to believe that yields will return to previous highs.
The report goes on to say that developments such as globalization and technology have changed the “equilibrium level of the federal funds rate,” justifying a lower rate for longer, something FOMC participants have acknowledged in recent years.
If FOMC participants are correct, the report opines, then it’s likely that the equilibrium level of the 10-year Treasury is “is probably not much more than that today – perhaps around 3.0-3.5%.” John Higgins and team see no reason why it should climb much higher than this level in the long-term.