As a new year gets underway, the big news so far has been the relentless march higher in bond yields. Since the Federal Reserve first cut the overnight Fed Funds Rate by 50bps in September, longer-term bond yields have uncharacteristically risen throughout a Fed easing cycle, with the 10-year Treasury higher by more than 100 basis points (1%) since then. It hit 4.79% yesterday, the highest level since late 2023.
One of the main drivers of this move higher has been further evidence of a very resilient economy, with inflation reports in the fourth quarter coming in on the stickier side, and last Friday’s surprisingly strong jobs report underscoring that the labor market remains quite firm. On top of that, there’s heightened policy uncertainty regarding the incoming Trump administration and the potential inflationary impact of new tariffs, as well as the possibility of even larger fiscal deficits if there’s a fresh round of tax cuts that could require the Treasury to add to an already enormous amount of bond issuance if they’re not paid for. This is reflected in the fact that a majority of the increase in bond yields has been driven by the so-called “term premium,” which is the extra compensation that investors demand to own longer-term bonds and accounts for factors beyond typical growth and inflation dynamics.
While the latest move in yields has been sharp, leading to some indigestion in the stock market recently, we believe that it’s more likely that the 10-year remains range bound between roughly 4% and 5%. First of all, while the Fed did dial back rate cut expectations for 2025 at their last meeting in December, they’re still planning on further easing and not tightening policy this year. Second, while the economy is still in reasonably good shape and recession risks are low, there are some soft spots that are feeling the strain of higher rates that should prevent an overheating, particularly the housing market and manufacturing sector. And finally, while tariffs are certainly a wild card for the inflation outlook, other key factors like wage growth and shelter costs appear more likely to soften in the coming year and allow for a further gradual moderation in overall prices.
From an investment standpoint, as the 10-year approaches the higher end of this range, bonds start to look more interesting with better value. However, if yields do rise above their previous high of 5%, that could create more of a headwind to the equity market and thus is a level that should be watched closely.
Source: Yardeni Research, as of 1/13/25
Carl Noble, CFA
Senior Vice President of Investments
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