The 10-year US treasury rate is an important indicator that is used as a measurement for economic sentiment and can also have a meaningful impact on the US stock market. Fluctuations in the 10-year rate can cause a handful of reactions across the markets and spark discussions on the underlying meaning behind the rate change. The Federal Reserve has recognized five factors that can influence rates:
- Economic conditions
- Demand for risk-free securities
- Monetary policy
Examining recent trends in the 10-year rate (see chart below) provide an interesting look on economic sentiment. Over the past 3 years, the 10yr treasury rate peaked at 3.24% on November 8th, 2018 as growth was strong and jobs were plentiful. Then, the rate slid to its lowest level in history on August 4th, 2020 at 0.52% as a result of the economic damage from COVID. As the economy began to recover, the rate moved up to 1.74% in March but has recently fallen precipitously to 1.19% as of August 3rd, 2021.
There is no denying that the recent rate moves have been volatile and supporting economic data has added to the uncertainty around the future direction of long-term interest rates. Investors are torn between worries of slowing growth, which generally supports a lower 10yr rate, versus heightened inflation that typically leads to higher rates.
The chart below shows the Consumer Price Index (CPI), a measure of inflation, which continues to rise to levels not seen since 2008. While CPI and long-term treasuries are never perfectly aligned, the recent trend of rising inflation coupled with a declining 10-year US Treasury Rate would be considered relatively abnormal in historical terms.
The argument supporting recent long-term rates trends revolve around temporary inflation that will begin to ease along with a slower-growing US economy as we return to a more normal course of business. The US economy definitely took a step back in 2020 due to COVID, which created an abnormal 2021 GDP growth of 6.39%. Estimates for the following years may be “slowing” but as shown in the chart below, it is returning to a more normalized and sustainable level as seen in past years.
In our opinion, we don’t believe current interest rates accurately reflect current or future market conditions. We believe economic growth and inflation will be elevated for the remainder of the year. The real yields (which is the current yield minus inflation) on 10-year treasuries are among the lowest in history, and prior occurrences have typically corrected with rising rates that can happen relatively quickly. As a result, we remain cautious on treasuries and would keep bond maturities relatively short.
As a result, we have recommended our Absolute Yield portfolio for clients looking to achieve premium income and are comfortable with higher volatility compared to traditional bonds. For those looking for protection from market corrections, we have recommended our Buffered Index portfolio which has elements of downside protection but with the ability to participate in the market upside.