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Any investors forced to sell beaten-up bonds lately knows the pain associated with higher long-term Treasury yields this year.
When yields rise, bond prices fall, especially on older bonds issued when yields were lower, because who doesn’t want to own basically the same debt, with the same risks, but suddenly at a better return?
But if you believe a U.S. recession is coming and inflation will continue to ease, you should also believe the 10-year Treasury yield will fall from its cycle peak to the cycle trough, said Macquarie strategists, in a Thursday client note.
Their chart shows the 10-year Treasury yield
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near 4.7% on Thursday and the Federal Reserve’s short-term policy rate at 5.25%-5.5%, as the two rates converge near the highest levels since the fateful summer of 2007.
10-year Treasury yields and the Fed-funds rate have been converging around levels last seen before the 2007-2009 global financial crisis.
Macquarie, Bloomberg
“When the Fed-funds rate and the 10-year Treasury yield calibrate, that’s when a recession often begins shortly thereafter,” said Matt Lloyd, chief investment strategist at Advisors Asset Management, in a call with MarketWatch.
From 2004 to 2006, the Fed was steadily raising interest rates to help cool the economy and a blistering housing market. By March 2007, Fed Chair Ben Bernanke told Congress the subprime mortgage crisis was “likely to be contained.” But fallout from adjustable-rate mortgages and the sub-prime debt crisis quickly forced a series of rate cuts that lowered the Fed’s policy rate to nearly zero, for almost a decade.
“We also recall that the 10-year yield jumped nearly to parity with the Fed’s policy rate in the late summer of 2007, when the economy appeared to be resilient to the worries about the problems in the “sub-prime” and “alt-A” mortgage markets,” wrote the Macquarie sales and trading strategy team led by Thierry Wizman.
“A soft-landing narrative then took over among many analysts, and stocks soared in the autumn of 2007. But we know what then happened by December – a global recession ensued, and 10-year yields crashed from roughly 5% to roughly 2%.”
The Fed in this cycle has been raising rates to pull down pandemic-era inflation. Also, instead of waves of mortgages repricing at unsustainable levels, most homeowners in this cycle have locked in historically low 30-year fixed rate mortgages, buffering many families from the shock of higher interest rates, but also complicating the Fed’s inflation battle.
But if you expect a slowdown, the Macquarie team says: buy bonds.
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were lower Thursday ahead of Friday’s jobs report for September, a potentially important gauge for the Fed as it works to pull still-elevated inflation back down to its 2% annual target.
