Borrowed Time
A recent paragraph of a Bloomberg news article sums up the current market backdrop with some sobering stats: “Treasury yields advanced on Wednesday, with those on benchmark 30-year debt approaching within a whisker of the closely watched 5% level. Yields on UK 30-year bonds increased to 5.75%, already the highest since 1998, while Japan’s 20-year notes climbed to the highest this century.” Indeed, the yield on a Bloomberg index of global long-term bonds reached its highest level since July 2009. On the surface, the reasons seem clear: Investors are demanding more compensation to hold longer-term debt due to high government spending and inflation risks around the world.Global 10+ Year Bond Yields
In the U.S. specifically, the rise in long-term yields is happening alongside a drop in short-term (2-year) yields that reflects the market’s expectation for a 25 basis point rate cut at the next Federal Reserve meeting on Sept. 17. As a result, the U.S. yield curve has steadily steepened, with the spread between 2-year and 10-year Treasuries hitting levels not seen since 2022 — the year inflation peaked and stock markets sharply contracted.
2y10y Treasury Yield Spread
Pressure is increasing on government debt levels and investors are “voting with their feet,” so to speak. Moves in yields like this could be warning signs from markets that the balance of risks is becoming unattractive from investors’ perspectives, and needs repricing.
On the Other Hand
There is always another side to the story, however. This year, inflation has plateaued despite widespread fears of reheating. Moreover, measures of inflation expectations have remained contained, which suggests that although inflation is running slightly hotter than the Fed’s 2% target, the economy has digested these levels and gotten comfortable with a new and elevated “normal.” And if you look at a rise in long-term yields as a representation of rising growth expectations, a steepening yield curve could be an indication of economic strength. Growth has remained steady, and the optimism around AI’s potential to increase productivity has helped boost future growth expectations. If rising long-term yields were warnings of more ominous things to come, we would also expect to see some sort of confirmation from the credit market, in the form of widening spreads (the difference between yields on corporate bonds and Treasurys), which hasn’t happened.Credit Spreads
Perhaps this is all the beginning of a repricing to more normalized levels of yields and inflation. I could make that argument and find a decent amount of historical data to support it. We experienced abnormally low levels of yields and inflation for a long time, so maybe time’s up.
Long-Term Stocks
The stock market has its own long-term assets, which typically fall into a growth bucket. These companies tend to invest high amounts now in order to drive future growth prospects, which can often take a long time to materialize. Over recent weeks, particularly the last five trading days, large-cap technology and tech-adjacent stocks have pulled back. This makes sense in concert with rising long-term yields: As the discount rate rises, the present value of assets dependent on that rate falls. But this is happening after many of those stocks have seen historic runs and rewarded long-term investors with handsome returns. Valuations are high historically speaking, so perhaps some normalization there is in order as well. This could be a healthy and necessary normalization process in the midst of an otherwise long-term bull market. It’s good to bring things back down toward earth once in a while. Or, this could be a warning sign we should heed and make sure we aren’t letting our risk appetites rise along with a rising market. I would argue we all could use a reminder of our appropriate risk levels, and make sure that’s reflected in our current portfolios.
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