10-year real yields in the US are flirting with 3%, which is… I don’t know. Scary? Intimidating?
For context, 10-year reals were -1.19% (that’s negative 120bps) around this time five years ago. Back then, a three-handle would’ve seemed ambitious for nominal 10-year yields.
On some interpretations, this is actually a good news story. The updated figure below shows you the breakdown of the 100bps+ increase in benchmark US yields this year.
As you can see, it’s all reals. Breakevens are just a handful of basis points wider. That’s a vote of confidence in the Fed’s capacity to rein in and otherwise check inflation over the longer haul assuming, of course, Kevin Warsh is allowed to do his job.
In the meantime, rising yields can be interpreted as a function of robust growth. When set against policy rates that are very elevated by post-Lehman standards (despite being 150bps lower versus the hiking-cycle peak), an accelerating growth impulse plainly suggests near-term neutral’s higher than some policymakers were inclined to believe.
Note that you needn’t trouble yourself with obscure academic concepts (i.e., r-star) to make the point. According to real-time GDP “nowcasting,” the US economy’s expanding at a 5% clip. Last week’s preliminary read on S&P Global’s PMIs for September tipped roughly the same blistering pace. Current policy settings simply aren’t restrictive, a reality Warsh acknowledged following the September rate hike.
The figure below, from BMO’s Ian Lyngen and Vail Hartman, shows you the evolution of US financial conditions following the meeting before the first hike of all tightening cycles going back more than three decades.
Long story short, financial conditions are easier versus end-July levels, even after the rate hike and relentless increase in 10-year yields.
“Aside from the single rate hike in 1997, this marks the only instance in which financial conditions have been easier than the pre-hike departure point at the current point in the tightening cycle,” Lyngen remarked. “If nothing else, this implies ample latitude for both policy rates and nominal Treasury yields to push higher in the coming months and quarters.”
A corollary says that absent a big drop in crude prices, the reals-driven Treasury selloff will only abate in the presence of evidence to suggest policy rates are working to brake (but hopefully not break, with an “e” in there) the economy and/or equities.
Note from the updated figure above that the rolling one-month increase in reals is approaching 60bps. That’s an enormous move over such a short period.
“The real 10-year US Treasury yield has risen by 53bps during the past month, crossing the two standard deviation speed limit that has historically been associated with negative equity market returns,” Goldman’s Ben Snider cautioned.
Of course, stocks have already de-rated meaningfully this year, but a lot of that’s due to a historic boom in earnings and forward profit expectations, not to rising yields. As Snider reminded investors, two-standard deviation moves in 10-year reals are typically associated with 4% pullbacks for the S&P 500.
As for the read-across for the broader economy of three-handle 10-year reals, that’s anyone’s guess. “The debate is whether the real economy can continue its impressive expansion given elevated real borrowing costs,” Lyngen said Tuesday, in a separate note. “The recent trajectory of the data suggests there remains sufficient momentum to do so, leaving us to ponder how long US consumers can continue contributing to real growth in light of elevated energy costs and the prospect of further declines in real purchasing power.”
