The 10-year Treasury yield has risen 60 basis points in five weeks, but that momentum could run out by now.
Written by Wolf Richter of Wolf Street.
On Friday, the 10-year Treasury yield rose to 4.25%, up 60 basis points from the day before the Fed’s monster rate cut (when the 10-year yield was 3.65%) and 5 basis points from a week ago. This 4.25% is a milestone of sorts.
The 10-year Treasury yield is currently at its highest since July 25th. It’s a 3 month round trip! On July 25, long-term interest rates began to fall more rapidly, as bets on the Fed’s rate cuts continued to gain momentum on the back of less-than-stellar labor market data and cooling inflation, with the Fed actually increasing by 50 basis points ( bp) continued to decline until the rate was cut. On September 18th, to the surprise of many, especially those in the home sales industry, long-term yields at that moment began to rise without falling further.
Then, about two weeks after the rate cut, a series of major overhauls began to take place, one after the other, with stronger labor markets and higher and higher inflation. And yields have skyrocketed (blue = effective federal funds rate, which the Fed targets with its headline rate).
However, short-term interest rates continue to fall, and the Bank is pricing in at least one 25 basis point cut this year, although it is not satisfied with a second 25 basis point cut. Mega cuts are out of the question. And they are pricing in cuts for next year, but at a slower pace than a few months ago.
The “yield curve” has continued to undergo an inversion process, with long-term yields rising and short-term yields falling simultaneously.
The normal state of government bond yields is that long-term yields are higher than short-term yields. The yield curve is considered to be “inverted” when long-term yields are below short-term yields, but this is because the Fed has raised interest rates rapidly, pushing up short-term Treasury yields and pushing long-term yields higher as well. It started happening in July, but more slowly. The yield curve is currently in the process of normalizing.
The chart below shows the “yield curve” showing yields on U.S. Treasuries with maturities ranging from one month to 30 years at three important dates.
Fri: July 25, 2024, before weak labor market data. Blue: September 17, 2024, the day before the Fed’s major rate cut. Red: Friday, October 25, 2024.
Yields on bonds with maturities of 7 years and above are currently at about the same level (red) as they were on July 25th (gold). This is a milestone.
And notice how much those yields have risen since the day before the rate cut (blue line). Yields on everything from 3-year to 20-year bonds rose by more than 60 basis points. This was a very fast round trip, falling in two months and rising the same distance in one month, amidst high volatility in the Treasury market.
The two-year U.S. Treasury yield has been above 4% all week and closed Friday at 4.11%, its highest since Aug. 1. The rise in yields was partly due to a series of events that dampened expectations for aggressive interest rate cuts. -Up revision.
Mortgage rates are about the same as but higher than the 10-year Treasury yield, and have risen sharply from their lowest point just before the rate cut. Mortgage News Daily’s daily measurement of 30-year fixed-rate mortgages has risen from a low of 6.11% on the eve of the rate cut to a current 6.90% in just over a month.
Mortgage rates in the decades before QE were typically above 6%, with long periods above 7-8%, and even higher in some years (Graph from Mortgage News Daily).
This turn of events was very unexpected for the real estate industry. They assured buyers and sellers that mortgage rates, which had already fallen from nearly 8% a year ago to nearly 6% by mid-September, would continue to fall, without a single rate cut. And there was talk of an interest rate of 4% or something.
Despite the sharp drop in mortgage interest rates from the end of October 2023 to September 17, 2023, the sales volume of existing homes decreased because prices were too high. And sales volumes have worsened in the past few weeks, as evidenced by a drop in mortgage applications.
The problem in today’s housing market — existing home sales in 2024 are on track to fall to the lowest volume since 1995 — is not mortgage rates. they returned to normal. That’s because during the free money era of the pandemic, home prices exploded, on top of already precariously high prices, by more than 50% in many markets in less than three years.
These prices are too high, not economically viable, and make no sense. Seeing this, many buyers went on strike. However, mortgage rates are now back in their normal range.
The drivers…
Long-term yields, especially over 10 years, are driven by the expected inflation over the life of the security and the expected supply of new Treasury securities to cover large deficits.
Concerns about inflation are a big motivator. No investor would want to own a Treasury bond with 10 years remaining at a purchase yield of 3.6% when the average inflation rate over the life of the security is 4%, 5%, or 6%.
Now, a tsunami of new Treasury bills to finance the budget deficit is washing over the land every week, and there is no indication that anyone in Congress or the White House intends to seriously discuss this with the American people. do not have. problem. As a result, debt has ballooned recklessly, and bond investors believe there is no relief in sight.
The Fed’s QT is the third factor that influences long-term yields to some extent. The Fed will continue to do so in 2022 after trillions of dollars of reckless quantitative easing suppressed long-term interest rates and mortgage rates to record lows, causing all sorts of huge problems, including skyrocketing home prices. I switched to QT in . So far, the Fed has cut nearly $2 trillion from its balance sheet. And QT will continue despite the rate cut.
How high will the 10-year yield rise?
The 10-year Treasury yield has risen significantly and rapidly, and our gut feeling is that it will run out of steam soon.
If the next few rounds of inflation readings are positive and labor market data weakens again, 10-year Treasury yields are likely to fall in such a scenario.
However, core CPI inflation has accelerated month-over-month for the third consecutive month, and if core CPI inflation rises in the coming months, driven by strong demand and a strong labor market, 10-year Treasury yields will also rise. There is a possibility that If you want to go a little further up the ladder, mortgage interest rates will exceed 7%.
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