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Saturday, 28 January 2023
U.S. Yields Near 3-Year High; Euro Stronger After French Election

U.S. Yields Near 3-Year High; Euro Stronger After French Election

2022-10-31

 

Long-awaited US yields have so far soared this year, with the yield on the benchmark 5-year note now around 3.1%, well above the historical average of about 1.5%. The surge has been particularly sharp in the past few weeks, with last Thursday’s rise of more than 1.5 points in a single day. Or does it? It may come as no surprise that the rise in yields has been driven largely by expectations of a stronger US economy, rather than any actual change in the level of the yield curve.

But what is a little surprising is that the anticipated change in the curve has not been accompanied by a change in expectations. In other words, the yield on the US 5-year note, which has been at levels that have not been seen since the financial crisis, has not just been a function of expectations but also of the reality of the US economy.

This makes the current rise in yields look more like a risk anticipation than a fact. The fundamental reasons for this remain the same: the Federal Reserve will not likely wind down its bond-buying program any time soon. Inflation, at around 2%, is also unlikely to take a turn for the better in the near term. And as the chart below shows, the yield curve has generally moved in the same direction as the overall US inflation rate.

US Yields: When Will It bottom?
As shown in the chart below, the yield on the 10-year note averages around 2.7% today, which is only slightly above the average of 2.1% recorded between 1900 and 2004.

This timeframe offers a good indication of how far interest rates will have to rise before the current bond buying policy ends. With interest rates at a level that has not been seen since the financial crisis, it is likely that yields will rise further before the end of the year.

What triggered the surge in yields?
So what triggered the recent fall in yields? In part, it was a reaction to a stronger Eurozone economy. Data published last week also suggested that the region’s economy grew at its fastest rate in more than two years in the third quarter of 2016, boosted by stronger domestic demand and a pickup in investment.

This growth, coupled with the European Central Bank’s decision to end its monetary policy normalization process this month and maintain interest rates at a record low of 0.15%, has led to expectations that the bank is soon going to start slowing the pace of its policy.

 
 
 

In other words, the combination of a stronger Euro and a rising US economy has led to higher yields.

What does this mean for the economy?
The combination of a stronger Euro and a rising US economy has led to higher yields, which in turn has led to expectations that the Federal Reserve will soon raise interest rates. This, in turn, has led to a plunge in the quality of the money supplied by the Fed and an increase in the amount of cash that is being exchanged for bonds. This increase in cash, however, has only happened because people have increased their purchases of bonds.

Is the yield curve a bubble?
It may come as no surprise that the rise in yields has been driven largely by expectations of a stronger US economy, rather than any actual change in the level of the yield curve.

But what is a little surprising is that the anticipated change in the curve has not been accompanied by a change in expectations. In other words, the yield on the US 5-year note, which has been at levels that have not been seen since the financial crisis, has not just been a function of expectations but also of the reality of the US economy.

This makes the current rise in yields look more like a risk anticipation than a fact. The fundamental reasons for this remain the same: the Federal Reserve will not likely wind down its bond-buying program any time soon. Inflation, at around 2%, is also unlikely to take a turn for the better in the near term. And as the chart below shows, the yield curve has generally moved in the same direction as the overall US inflation rate.

Is the prospect of a stronger US economy the real reason for the fall in yields?
The yield on the 10-year note averages around 2.7% today, which is only slightly above the average of 2.1% recorded between 1900 and 2004. This timeframe offers a good indication of how far interest rates will have to rise before the current bond buying policy ends. With interest rates at a level that has not been seen since the financial crisis, it is likely that yields will rise further before the end of the year.

Conclusion
The rise in yields has been driven largely by expectations of a stronger US economy, rather than any actual change in the level of the yield curve.This means that the yield on the 10-year note, which has been at levels that have not been seen since the financial crisis, has not just been a function of expectations but also of the reality of the US economy.This makes the current rise in yields look more like a risk anticipation than a fact. The fundamental reasons for this remain the same: the Federal Reserve will not likely wind down its bond-buying program any time soon. In other words, the yield on the 10-year note, which has been at levels that have not been seen since the financial crisis, has not just been a function of expectations but also of the reality of the US economy.

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