The minutes from the Federal Reserve’s January meeting helped push the yield on the 10-year US Treasury to just shy of 3%.
For some, this is as an important psychological barrier - the highest level to which yields have climbed since the beginning of 2014, and around 60 basis points higher than at the turn of the year. They have suggested that a breakout above this level will herald an end to the bull market for bonds that has lasted for more than a quarter of a century.
Fears that a rise in 10-year yields above 3% will herald a bear market are somewhat irrational.
From our perspective, however, fears that a rise in 10-year yields above 3% will herald a bear market are somewhat irrational. There is nothing significant about any particular yield level. What matters is what causes the price change - not the price change per se. The expectation of further rate hikes has driven the yield higher.
While the US 10-year yield has retreated somewhat in the past few days, it will probably push above 3% at some stage. However, that level is unlikely to be maintained for an extended period of time. ‘Three’ in this context is not a particularly important number, given that nominal US GDP growth in 2019 is expected to approach 5%.
In the past, bond fund managers tended to apply the rule of thumb that nominal GDP generally tracks the same path as the 10-year yield. There is a good reason for this – economic output should be fairly close to the price of money.
That said, we have not been in anything like a normal environment for the past 11 years. We are still in the midst of an era of abnormal stimulus from central banks. The European Central Bank and the Bank of Japan – and, to some degree, the Bank of England and the Federal Reserve (Fed) - have all expanded their balance sheets over the past 11 years.
As the Fed moves from quantitative easing to policy normalisation (aka quantitative tightening) its balance sheet will contract once more. But the overhang of this pile of debt – together with a similar pile held in both corporate and consumer hands – will act as a natural brake on yields rising for any prolonged period of time.