Dec 6, 2023 - Economy

The meaning behind the reversal of long-term rates

Data: Federal Reserve; Chart: Axios Visuals

September and October featured a remarkable surge in longer-term interest rates, a development that policymakers, market mavens, and economics newsletter writers alike scrutinized for what it might say about the future.

  • Nevermind. Since then, it has mostly reversed.

Why it matters: Market sentiment has shifted abruptly in the last seven weeks as fears have eased that the U.S. is getting locked into an era of much higher borrowing costs.

  • That means a bit of relief — relative to October, at least — for homebuyers, corporate borrowers and the government's fiscal position.

By the numbers: The round trip in long-term bond yields has been remarkable. The 10-year U.S. Treasury yield rose from 3.85% in late July to a hair under 5% on Oct. 19.

  • Since that day, it has fallen back to 4.12% (as of 10:50am ET Wednesday).
  • That is being passed through to other borrowing rates. Most notably for would-be homebuyers, Mortgage News Daily's measure of the average 30-year fixed-rate home loans also peaked Oct. 19, at 8.03%, and was down to 7.08% Tuesday.

State of play: In the staid market for Treasuries, those are the kinds of wild swings usually seen in moments of extreme crisis or major policy pivots. Economic data, fiscal policymaking and Fed communications have shown only subtle evolution in that time.

  • The move is partly driven by investors' falling expectations for future inflation — surely prompted by a series of comforting pieces of inflation data in recent weeks.
  • Pricing of inflation-protected bonds currently implies a 2.17% annual inflation rate over the coming decade, down from 2.49% on Oct. 19.

Yes, but: It's not just diminishing inflation expectations driving the shift. The 10-year real interest rate is down about 0.4 percentage points in the same span.

  • That suggests the smart money is backing away from the thesis — much discussed in September and October — that U.S. interest rates will need to remain high indefinitely as a result of high fiscal deficits and falling global demand for Treasuries.
  • It also supports some of the more technical explanations offered for the surge in yields during early fall, including those involving crowded trading positions unwinding and rising yields on Japanese debt causing capital flows.

Between the lines: The reversal in long-term borrowing costs reduces the risk to interest-sensitive sectors of the U.S. economy in 2024 — housing, regional banks and commercial real estate among them. But it is a signal that the robust growth of this past summer could be a thing of the past.

  • After all, lower rates only make sense if the economy continues slowing while inflation pressures continue to dissipate — which would give the Fed license to cut its policy rate as aggressively in 2024 as many in markets now see as likely.

The bottom line: The rapid decline in yields, writes Quincy Krosby, chief global strategist for LPL Research, in a note, "is concerning as it reflects a slowing economic backdrop, but perhaps one that is deteriorating at a faster than desired clip."

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