Yields on long-term US Treasury securities have risen, and prices have fallen, farther and faster over the past few years than at any time since the 1980s. This has wreaked no small amount of havoc — contributing, for example, to the recent demise of several regional banks.
I have what might be disconcerting news: It’s not over.
Since last fall, the 10-year Treasury yield has remained in a narrow range near its current level of 3.75%. There’s little reason for it to stay there, and many reasons to expect it to move considerably higher.
First, with the economy still strong, the labor market extraordinarily tight and inflation stubbornly high, the Federal Reserve will probably be taking short-term interest rates higher for longer. In their most recent projections, two thirds of officials on the policy-making Federal Open Market Committee saw at least two more 0.25-percentage-point increases this year, while the median forecast was for the federal funds rate to remain above 4% at the end of 2024. They also appear to be increasing their estimate of the “neutral” rate that neither restrains nor boosts the economy, suggesting that a higher fed funds rate will be required to combat any given level of inflation. This makes sense: With baby boomers spending down retirement accounts, the government running large budget deficits and vast capital investments required in supply chains and green technology, higher rates will be necessary to balance demand for borrowing with a shrinking supply of savings.
Second, over time, average inflation — a key component of bond yields — will almost certainly be higher than the Fed’s 2% target. The central bank’s monetary policy framework is asymmetric. When inflation is too low, it wants to compensate by aiming above 2%, lest inflation expectations decline and erode its ability to stimulate growth (if, for example, inflation expectations fell to zero, taking interest rates to the zero lower bound would have little stimulative effect). But when inflation is too high, Fed policymakers merely aim to get back to the 2% target. Over time, the result should be more upside than downside misses.
