10-Year Treasury Yield Drops In Response To Falling Prices

Key takeaways

• The latest PPI numbers confirmed that inflation is on a downward trend and that, barring any significant world events that may influence American markets, we might expect to see that trend continue
• When inflation goes down, 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 a hard-and-fast predictor of recession

After the latest numbers from the Producer Price Index (PPI) revealed a drop in wholesale pricing last week, the markets responded in a big way. In particular, yields on the 10-year Treasury fell in spectacular fashion.

In the time since, yields have bounced back up a bit, but they’re far from recovered. Overall, they’re following a downward trend that we’ve 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 influenced so heavily by the latest PPI report.

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Latest PPI report reveals slowdown in pricing

The PPI measures the amount of money American businesses receive for their goods and services. As of the latest report, the PPI showed a 0.5% decrease in wholesale pricing in December.

This was larger than anyone expected, as industry predictions called for a 0.1% decrease. However, it does follow the announcement of a larger-than-expected decrease in inflation, with December’s numbers bringing the year-over-year number down to 6.5%.

The announcement of the latest PPI numbers affirms that inflation may continue its downward trend, which could be a relief to the Fed and American consumers alike. Though most American investors and borrowers would prefer the Fed slow its pace of interest rate hikes in light of the latest news, we’ll have to wait until February 1, 2023, to see the central bank’s reaction.

Yields fall from the highest they’ve been since the Great Recession

From July 2022 through October 2022, yields on the 10-year Treasury reached the highest they’ve been since October 2009 through January 2010, when Americans were feeling powerful aftershocks of the “2008” Recession. The monetary policy the Fed has pursued to fight inflation, which peaked at 9.1% in June 2022, had pushed yields on Treasuries higher than they have been in over a decade.

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

This consensus can be seen in a swift downward trajectory of the yield on the 10-year Treasury. While yields have been up and down in the time in between, as a whole, investor sentiment appears to believe that inflation is heading in the right direction, so yields are also headed down.

The most recent dip after last week’s PPI announcement was just the latest one on this journey. According to the U.S. Department of the Treasury, yields fell to 3.37% following the news. However, they’ve risen back to 3.48% as of January 20, 2023. Before the PPI report, they were at 3.53%.

For perspective, in October 2022, yields reached 4.25%.

The inverted yield curve may be a cause for concern

While decreased yields on the 10-year Treasury are an indicator that inflation is down, they’re also a cause for concern in today’s environment because yields on the three-month Treasury are higher, sitting at 4.72% as of January 20, 2023.

This creates an inverted yield curve, which means that the yield you’ll get on short-term government Treasuries is greater than the yield on long-term government Treasuries. In this case, we’re seeing an inverted yield curve because the Fed has hiked rates at a dramatic pace over the past year, making it much more expensive to borrow money.

Some investors consider the inverted yield curve to be a canary in a coal mine, predicting recessionary times ahead. This may yet be true, but it’s too soon to tell. The size of the gap 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 these correlations aren’t necessarily accurate. We knew short-term borrowing would get more expensive when rates started rising, and the Fed has always been aware that a recession would be a potential consequence of their actions.

However, they’ve been doing their best to avoid that outcome. Currently, some are hoping the Fed can pull off a soft landing.

The 10-year yield affects mortgage rates

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

If the yield on the 10-year Treasury continues to decline, we might expect to see mortgage rates come down further, alleviating some of the pressure on the housing market. If it gets less expensive to purchase a home, it could have an overall net positive impact on short-term Treasury yields, easing the severity of the inverted curve.

Alternately, we could topple into an official recession. There are no crystal balls here, but there are reasons to be hopeful amidst all the anxiety.

The bottom line

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

We can view this as a hopeful sign of things to come for the American economy in the coming months, but that optimism needs to be buffered by a realistic acknowledgment that the Fed isn’t out of the woods yet.

While they may be able to curb inflation without causing a recession, a recession is still a possibility. This is particularly true when you consider global conflict and the consequences of an ongoing pandemic.

Recessions should already be worked into your long-term investing plans, but that doesn’t make them less stressful. If you want to have artificial intelligence do the heavy lifting when it comes to researching your investments, try one of Q.ai’s Investment Kits. You can even turn on Portfolio Protection for added peace of mind.

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