10YR US Treasury Yields Soaring; Inverted Yield Curve Steepening

In the last week or two we’ve seen a very dramatic rise in the 10YR US Treasury yield.

Currently hovering at roughly 4.6%, the 10YR US Treasury yield is at its highest level since 2007.

Price pressure on longer-term yields can be condensed into the following two factors: short-term yields and term premium. Short-term yields are generally easier to predict, as they tend to follow the movements to the US Fed Funds rate quite closely. ?

Term premium can be thought of as the compensation market participants require to account for interest rate uncertainty. In a “higher for longer” environment where interest rates on longer-term maturities will cause uncertainty to increase, this dynamic has driven term premia to increase +100bps in just 3 months (since July).

Here we can clearly see how the recent upward move in the 10YR US Treasury yield occurred parallel to the term premium of the 10YR US Treasury yield spiking upward in conjunction.

This has resulted in the 10YR-2YR yield curve steepening from a max inversion of roughly -106% to a recent -49%, due to longer-term yields rapidly rising. But where yields will go from here is a significant question mark. Some believe yields are going to continue to rise given the dynamic described above isn’t likely to change soon, while others believe we’re near a peak. We’ll have to ultimately see how this plays out and where the US Fed lands in all this.

As far as the US equity market goes, I don’t see this as good longer-term news, or even short-term quite frankly. We currently have a trifecta of rising asset prices that are historically detrimental to equity valuations: crude oil, real rates/yields, & the USD are all rising simultaneously. All three are historically considered longer-term headwinds for equity market prices. I would not expect US equity valuations to consolidate meaningfully until the US economy is in recession.

A final note: I wouldn’t be too hasty to conclude rapidly rising term premia is a big positive for the economy or financial markets, at all. This calculation is telling us that market participants are getting more concerned about longer-term credit conditions, as we looked at the term premia for longer-term 10YR US yields. With credit spreads lagging in such relatively extreme extent as they have throughout the majority of this cycle, my sense is it's far too premature to dismiss the possibility of a serious credit event occurring - even in the short to mid-term.