Bond Yields: Good News, Bad News or Both?

Bond Yields: Good News, Bad News or Both?

Bond yields can tell us many things, but determining what those things are can be challenging today.

Yields have been rising and one positive is that investors appear to be betting on the U.S. over the rest of the world this year. The gap between the yield for 10-year Treasurys and German bunds recently rose to its highest level in three decades, which is a sign that foreign demand for U.S. debt is high.

Conversely, though, the yield curve has been flattening, which is typically a sign of an economic slowdown. The yield curve is the gap between short-term and long-term Treasury yields.

U.S. Treasurys have been increasingly appealing to foreign investors in recent years, because interest rates throughout Europe have been even lower than U.S. rates. In some cases, as we’ve reported, they’ve been negative.

The spread between 10-year Treasurys and German bunds “is probably anticipating the U.S. economy is going to grow stronger than the rest of the world, and Germany in particular,” said Jack McIntyre, who manages global bond portfolios at Brandywine Global Investment Management.

Yields are also being driven higher by the Trump administration’s tax reform, which appears to be stimulating growth and increasing borrowing needs, which will increase the supply of new bonds, causing yields to rise.

Fed Impact on Yield

But the yield is likely to be driven more than anything by actions of the Federal Reserve Board. Yields rose, stabilized and finally fell last week after minutes of the Fed’s latest meeting were published, as the Fed announced that it would temporarily allow inflation to run a bit above its 2% target.

That’s a signal that the Fed will continue to proceed with caution, increasing interest rates slowly even as the economy continues to strengthen. Central banks often raise rates in response to rising inflation.

It should surprise no one that the Fed is increasing — “normalizing,” in Fed parlance — interest rates, which have been close to zero since the financial crisis.

Yet as rates increase, even if increasing rates reflect a stronger economy, it could have a negative impact on both stock and bond prices. Yields move in the opposite direction of bond prices and higher rates make stocks less attractive. A recent strong retail sales report drove the 10-year Treasury yield to 3.09% and caused the Dow Jones Industrial Average to fall more than 200 points.

So the good news is that yields are rising. And the bad news is that yields are rising.

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