Aptus Capital Advisors portfolio manager and head of fixed income John Luke Tyner stated that the 10-year U.S. Treasury yield has largely remained within a relatively narrow range of 4% to 4.5% for most of the past year. A significant catalyst is required to trigger a lasting breakout in either direction.
U.S. Treasuries have been under pressure from both inflation concerns and growth worries. On one hand, inflation fears driven by high energy prices have kept yields elevated; on the other, concerns about long-term growth risks have capped the upside for yields.
Tyner said, "I do think that to sustainably break out of this range, we need a bigger catalyst." He suggested such a catalyst could be a "significant growth scare" or a sharp acceleration in inflation, though neither scenario currently seems likely.
Following the outbreak of war between the U.S. and Iran on February 28, inflation fears triggered by surging oil prices led to a sharp rise in U.S. and global bond yields. According to Tradeweb data, the 10-year U.S. Treasury yield reached a wartime high of 4.484% on March 27. The yield was last reported at 4.455%.
While significant growth issues could pull U.S. Treasury yields lower, the U.S. labor market has remained resilient in recent months, with the unemployment rate holding steady at 4.3% in April. Meanwhile, persistent inflation pressures and fiscal instability have kept yields at higher levels.
He stated, "If nominal GDP remains around 5%, the 10-year Treasury yield should stay elevated."
Tyner noted that for U.S. Treasury yields to move significantly higher, the year-over-year core inflation rate would need to return to the 3.5% to 4% range, which could push overall year-over-year inflation above 5%. He considers this outcome unlikely.
Data released Tuesday showed U.S. headline year-over-year CPI accelerated to 3.8% in April from 3.3% in March, exceeding the average analyst forecast of 3.7%. Core year-over-year CPI was 2.8%, above the 2.7% expected by analysts.
Tyner said, "Elevated energy prices should keep yields high because oil prices largely dictate the direction of the economy." He pointed to costs in transportation, food, input costs, and manufacturing.
He mentioned that a looming question is whether price increases will trigger some form of demand destruction, which could then restrain yields.
Tyner expressed skepticism regarding the risk of high stagflation facing the U.S. economy. Stagflation refers to the combination of high inflation and weak growth.
He stated, "While it's understandable that Federal Reserve officials are vigilant about stagflation, I believe the risks are overstated."
U.S. energy independence insulates it from the factors that caused stagflation in the past.
Tyner said, "The U.S. economy is fundamentally different from the 1970s. The U.S. is the world's largest oil producer and one of the top three oil exporters, so rising oil prices are actually a net positive for U.S. income and GDP."
Although U.S. Treasuries maintain their safe-haven status, high debt levels and substantial government spending may deter some Treasury investors.
Tyner said, "The fiscal risks look unfavorable. The U.S. is adding about $1 trillion in debt every five months."
The U.S. Treasury yield curve is not steep enough to adequately compensate investors for duration risk, meaning they need to seek protection elsewhere.
He stated, "For investors, it is crucial to seek other types of portfolio stabilization tools, such as portfolio hedges and energy assets, which have proven to have better correlations with portfolios during periods of market turmoil."
He noted that while short-term bonds, such as 1- to 3-year U.S. Treasuries, have helped protect capital during recent market declines, investors should remain cautious about long-term U.S. Treasuries.
He said, "I do believe that long-term U.S. Treasuries will continue to lose money on a real or after-tax basis."
Even so, it is not uncommon for the bond market to struggle during periods of high inflation.
Tyner said, "It is normal to see bonds struggle during inflationary periods because fixed assets are being continuously devalued."
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