The Rise And Fall Of Treasury Yields — What They Signal For The Economy, Inflation And Your Portfolio

Key takeaways

• The 10-year Treasury yield is a financial benchmark used as a comparison tool for things like mortgage rates. In November 2022, mortgage interest rates came down despite Federal Reserve rate hikes because they had deviated so far from the 10-year Treasury yield.
• The relationship between the 10-year Treasury yield and three-month Treasury yield is often viewed as an economic indicator, though Fed research reveals it is more of an indicator of investor sentiment than actual economic performance. Regardless, the current relationship between the two could have a negative impact on the economy if the gap between them grows larger, or the gap persists for a longer period of time.
• Predicting what will happen next with Treasury yields is dicey territory, but whatever outcome arises will sit at the intersection of investor confidence, inflation, and the Fed’s attempts to combat that inflation.

Since the beginning of the year, the 10-year Treasury yield has fallen from 3.879% to 3.484% as of Jan. 20, 2023. This fall hasn’t been a straight downward line – it has bounced up and down along the way. Over the past few days, it’s been on an upward trend. The last time we saw rates like these was at the beginning of December 2022.

Last year was a year of escalation for Treasury yields. They started 2022 at 1.512%. That was after climbing up from a low of 0.553% in August of 2020, the summer after the pandemic hit.

What do all these numbers mean for your investments? It’s a little tricky to wrap your head around, but today we’ll take a look at what treasury yields mean for the economy, inflation and ultimately, your portfolio. Q.ai is in your corner.

The significance of the 10-year Treasury yield

There are different treasury yields for different terms ranging from weeks to multiple decades. But the 10-year Treasury yield is the star of the show. This metric is used as a standard for all types of other financial benchmarks, like mortgage interest rates.

For example, in 2022, mortgage interest rates rose spectacularly as the Fed hiked interest rates. This growth got so out of control that mortgage rates went from just above 3% in January to over 7% by October 2022.

At that point, mortgage interest rates had started outpacing the 10-year Treasury yield to such a large degree that there was a market correction. In November 2022, mortgage interest rates came back down below 7% and have stayed there since.

While that’s still higher than we’ve seen in decades, it is notable that mortgage rates came down despite continued Federal rate hikes. The phenomenon has the 10-year metric to thank.

If the 10-year Treasury yield were to go down and stay down, we could reasonably expect to see a decrease in mortgage interest rates, which would be a boon to the stalled-out housing market.

What the 10-year Treasury yield means for your portfolio

Right now, we’re in limbo, waiting to see what will happen. While the 10-yearTreasury yield fell impressively throughout November and early December, this week it’s on an upward trajectory again. This may be a short-term trend, or it could be the beginning of a more sustained cycle.

Remember that one of the main contributing factors to Treasury yields is investor demand. In a way, what happens to these yields in the future depends on how we all collectively invest – whether we feel confident enough to pursue riskier investments in the stock market or nervous enough to want to keep our investments incredibly safe via government Treasuries.

Inflation and the Fed’s reaction to it will play a large role as well. We’d expect to see high yields in times when investors were feeling positive about the present and future state of the economy. But over the past two years, despite the economy going through some rather large upheavals, the 10-year yield has risen thanks to runaway inflation.

Recessionary worries with an inverted yield curve

In a healthy economy, you’d expect to see short-term treasuries pay lower yields than long-term treasuries. That’s because long-term treasuries come with bigger risk of interest rate movement, so investors are interested in a higher return.

What we’re seeing right now, though, is something known as an inverted yield curve. Shorter-term treasuries are paying higher yields than long-term treasuries. As of Jan. 20, 2023, the yield on a three-month Treasury is 4.662%, while the yield on a 10-year Treasury is 3.484%.

Some consider an inverted yield curve to be a harbinger of an oncoming recession. That can be true, but a lot hinges on how big the gap between the two is, and how long the inverted curve lasts.

You might have heard that the two-year treasury had an inverted curve compared to the 10-year treasury in 2022. That did happen at certain points, but the gap corrected itself multiple times.

More notably, in October 2022, the shorter-term three-month/10-year yield inverted. The gap between the two became more pronounced at the tail end of the year, and continued into the first few weeks of 2023.

The three-month yield is more notable because it has a greater effect on bank’s willingness to lend money over the short-term. When the yield curve is inverted, they’re more likely to pull back – which can lead to recessionary circumstances in the economy.

This particular curve hasn’t been inverted long enough yet to be a certain peek into the future. While mortgage rates have marginally corrected, they’re still quite high – borrowing money is still expensive.

But America’s job market is hot, with unemployment rates below 4%. If the U.S. economy can evade mass layoffs in the current economic environment, a recession may not appear.

Even with the strong job market, and perhaps in part because of it, the Fed is planning on raising rates further to continue combating inflation throughout 2023. These hikes have a particularly pronounced effect on short-term Treasuries, like the three-year. This means we are at risk of seeing the yield curve invert further, which would be bad for the economy.

Which came first – investor fears or the inverted yield curve?

While the inverted yield curve is sometimes viewed as a predictor of recession, Federal Reserve research reveals that it is more of a reflection of investor predictions about a recession rather than a definitive predictor of a recession in and of itself. This is particularly true when looking at the spread between two-year and 10-year Treasuries, but the researchers said it can apply to the spread between any two Treasuries.

It cites inflation as another practical reason for the inverted yield curve. If investors expect inflation to continue easing, we might expect to see the gap between the three-year and 10-year Treasuries move closer together. This will be more likely when the Fed gets inflation back below 2%. Then, investors will have less of a reason to expect rising short-term interest rates.

The bottom line

These economic times we’re living through may be unprecedented, but that doesn’t mean we shouldn’t have planned for them. While we never know what will cause economic upheaval, we can regularly predict that some type of recession or unease in the economy will happen as a natural part of the economic cycle.

Despite these periods of upheaval and uncertainty, over long time horizons, the stock market has historically experienced net growth.

That doesn’t mean there’s nothing you can do to calm investing anxieties at this moment. The first and likely most important thing you can do is sit down with your financial advisor to review your asset allocation, personalized financial goals, and the risk tolerance you can reasonably sustain in order to meet those goals.

If you are investing through Q.ai, we do provide Inflation Kits specifically for moments like these. On all of our Investment Kits, you can also turn on Portfolio Protection, which protects your gains and reduces your losses for further peace of mind.

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