Is 3% a top for US Treasury Yields?

The US benchmark yield has spiked this year, returning to the levels just before the 2018 correction in the markets. Will the Fed reconsider or is a bigger breakout coming?

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The new normal

In the past 12 years, the 10-year T-bond has poked above 3.0% only three times, and each time was followed by consternation in the markets. Higher bond yields, of course, mean that the cost of credit rises. In turn that is seen as having a "limiting" effect because higher borrowing costs imply slower economic growth.

Some analysts are suggesting the latest moves in bonds show that the Fed's policy is having an effect. With the peak over and quick return below 3.0%, some technical analysts might have thought that it was a sign that showed a technical resistance. But the move lower also had a fundamental explanation: Yields rose in response to the Fed raising rates, and then retreated after higher-than-expected inflation data as investors became more concerned about rising inflation.

Getting the books to balance

Bond yields and inflation are intimately related, because the money supply is determined by the cost of credit. With higher interest rates, less people take out loans, meaning that less money is "created". And that means less inflationary pressure.

So, if already interest rates are slowing down inflation, it could mean that interest rates might not need to rise as much. But, bond yields are always above the Fed policy rate unless there is something seriously wrong with the financial system. And most analysts expect the Fed funds rate to reach 3.0% by the end of the year. Meaning that even if yields stumble for a bit now, if the Fed keeps up its current tightening cycle, yields will be substantially higher by the end of the year.

The effect on the markets? Continuing dollar strength and a depressed stock market look like ‘the order of the day’. But in the short-term the US10Y could go either way until the next Fed meeting at least.

US10Y prints bearish formation

The 10-year yield missed the previous top of 3.25% and reversed – for now. The weekly bar has printed a bearish engulfing formation from 3.16% down, with next notable support at 2.62%. If 2.62% holds firm, fresh highs can be expected.

Below 2.62% though, momentum will have been lost and participants will shift focus on the gap at 2%, and then the 1.34%-1.76% range. The yield likely hangs on the next two weeks’ price action.

Source: TradingView

Key takeaway

The 10-year T-bond has only once gone above 3% in the past 12 years, and it usually follows a pattern of rising interest rates. The recent fall is technical and fundamental.

Bond yields are influenced by inflation. If interest rates are slowing down inflation, bond yields may not need to rise as much, affecting the yield negatively. However, if the Fed keeps up with their tightening cycle, then the market could become more bullish.