Why Are 10-Year Government Bonds Important to the Economy Right Now?
Yields on longer-term Treasurys, including the 10-year note, set a floor on borrowing costs for both businesses and consumers. More importantly, changes in the yield curve on government bonds often serve as a signal of economic changes.
In simple terms, the yield curve indicates the movement of interest rates (the yield) as a bond matures. Under normal circumstances, the yield on long-term debt such as a 10-year bond will have a higher yield than short-term debt. But sometimes the yield becomes “inverted,” meaning bonds with shorter maturity periods have higher yields than bonds with longer maturity periods.
Historically, inverted yield curves have been fairly reliable predictors of economic trouble on the horizon — and the yield curve has already inverted this year.
That’s one reason the eyes of economists will be on the Federal Reserve’s two-day meeting, scheduled to conclude on Wednesday, Dec. 14. As the WSJ noted, the Fed can influence bond yields by changing short-term interest rates or projecting what those rates will be over the next couple of years.
But trying to predict the 10-year yield is not always easy, as recent trends have shown. The 10-year yield stood at a low 3.501% Tuesday. That was down more than 0.7 percentage points from its November peak and also down from 3.611% on Monday.
If the Fed decides to hike interest rates more than expected, the 10-year yield could climb — unless it doesn’t. A lot depends on how investors react, and many of them have had a hard time deciphering the Fed’s message on inflation and interest rates.
“The problem is the more hawkish (Fed Chairman Jerome) Powell sounds in the face of inflation on the downswing and rising recession risks, the more the yield curve inverts,” Donald Ellenberger, a senior portfolio manager at Federated Hermes, told the WSJ. “Powell can push up short-term rates, but it’s getting increasingly difficult for him to push up long-term rates.”
If long-term bond yields fall, it becomes harder for the Fed to bring inflation down to the central bank’s 2% annual target. It’s especially hard now, with inflation at around 7%.
According to some analysts, one reason longer-term yields have fallen lately is that the Fed has signaled it might slow the pace of rate increases even as hikes extend into 2023, as expected. A further inversion of the yield curve could convince the Fed to drive longer-term yields higher by also raising short-term rates even higher.
All of which is to say that the Fed still holds the important cards in helping to influence the direction of 10-year bonds — and the economy.
“Markets can be more optimistic or more pessimistic, but the Fed ultimately writes the story,” said William Dudley, former New York Fed president and chief U.S. economist at Goldman Sachs.
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