Yield on 10-year Treasuries falls in response to falling prices

Yield on 10-year Treasuries falls in response to falling prices
Yield on 10-year Treasuries falls in response to falling prices

AFP via Getty Images

Key points to remember

  • The latest PPI figures have confirmed that inflation is on a downward trend and that barring major global events that could influence US markets, we could expect this trend to continue.
  • When inflation drops, the 10-year Treasury yield tends to follow
  • While cooling inflation can also cause inverted yield curves, this economic indicator hasn’t lasted long enough to be an infallible predictor of recession.

After the latest Producer Price Index (PPI) figures showed a drop in wholesale prices last week, markets reacted in a big way. In particular, 10-year Treasury bond yields have fallen dramatically.

Since then, yields have rebounded a little, but they are far from being recovered. Overall, they are following a downward trend that we have seen since November 2022, but there have been ups and downs.

Here’s what falling 10-year Treasury yields mean for your portfolio and why they were so heavily influenced by the latest PPI report.

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Latest PPI report reveals slowing prices

The PPI measures the amount of money American companies receive for their goods and services. According to the latest report, the PPI showed a 0.5% decline in wholesale prices in December.

This was more than expected, as industry forecasts called for a decline of 0.1%. However, this follows news of a bigger than expected decline in inflation, with December figures bringing the year-on-year figure down to 6.5%.

The announcement of the latest PPI figures affirms that inflation may continue its downward trend, which could be a relief for the Fed and US consumers. Although most US investors and borrowers would prefer the Fed to slow its pace of raising interest rates in light of the latest news, it will take until February 1, 2023 to see the central bank’s reaction.

Yields fall from their highest level since the Great Recession

From July 2022 to October 2022, 10-year Treasury yields hit their highest level since October 2009 to January 2010, when Americans were feeling powerful aftershocks from the “2008” recession. The Fed’s monetary policy to fight inflation, which peaked at 9.1% in June 2022, has pushed Treasury yields higher than they have been in more than a decade .

Since November, the general consensus has been that inflation has been on a downward trend, at least for now. We have no idea what lies ahead for 2023, especially with geopolitical conflicts and new pandemic concerns raging across the globe.

This consensus translates into a rapid downward trajectory of the 10-year Treasury yield. While yields have risen and fallen in the meantime, overall investor sentiment appears to believe that inflation is headed in the right direction, so yields are also trending lower.

The most recent decline after last week’s PPI announcement was just the latest in this journey. Yields fell to 3.37% after the news, according to the US Treasury Department. However, they recovered to 3.48% on January 20, 2023. Before the PPI report, they were at 3.53%.

As a reminder, in October 2022, yields reached 4.25%.

The inverted yield curve may be cause for concern

While the decline in 10-year Treasury yields is an indicator that inflation is falling, it is also cause for concern in the current environment, as three-month Treasury yields are higher at 4.72% as of January 20, 2023.

This creates an inverted yield curve, which means that the yield you will get on short-term treasury bills is higher than the yield on long-term treasury bills. In this case, we are seeing an inverted yield curve because the Fed has been raising rates at a dramatic pace over the past year, which has made it much more expensive to borrow money.

Some investors view the inverted yield curve as a canary in a coal mine, predicting recession times ahead. That may still be true, but it’s too early to tell. The size of the spread between the two rates matters, as does the duration of the curve. As of this month, bankers aren’t convinced it’s a useful predictive tool unless it continues.

The Fed notes that its research has proven that these correlations are not necessarily accurate. We knew that short-term borrowing would become more expensive when rates started to rise, and the Fed was always aware that a recession would be a potential consequence of its actions.

However, they did their best to avoid this outcome. Currently, some are hoping the Fed will pull off a soft landing.

10-year yield affects mortgage rates

One good thing about the 10-year Treasury yield is that mortgage rates are closely tied to this metric. By October 2022, mortgage interest rates had gotten so out of control against the 10-year Treasury that we saw a market correction in November 2022. Mortgage interest rates fell and then stabilized somewhat despite the continued federal rate hikes.

If the yield on 10-year Treasury bonds continues to fall, one would expect to see mortgage rates fall further, easing some of the pressure on the housing market. If it becomes cheaper to buy a home, that could have an overall net positive impact on short-term Treasury yields, mitigating the severity of the inverted curve.

Alternatively, we could tip into an official recession. There are no crystal balls here, but there are reasons for hope amidst all the anxiety.

The bottom line

Inflation is finally headed down, but it still has a long way to go before it hits the Fed’s 2% target. Since it seems on the way out, the 10-year Treasury yield is also heading in the same direction.

We can take this as an encouraging sign of things to come for the US economy in the months ahead, but this optimism needs to be tempered by a realistic acknowledgment that the Fed is not out of the woods just yet.

Although they may be able to rein in inflation without causing a recession, a recession is still a possibility. This is especially true when considering global conflicts and the aftermath of an ongoing pandemic.

Recessions should already be factored into your long-term investment plans, but that doesn’t make them any less stressful. If you want artificial intelligence to do the heavy lifting when it comes to researching your investments, try one of Q.ai’s investment kits. You can even enable Wallet Protection for added peace of mind.

Download Q.ai today to access AI-powered investment strategies.

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