The Runway Toward Higher Treasury Yields Looks Free and Clear

The obstacles to higher yields in the world’s biggest debt market are slowly melting away.

Bond bears appear to be having more than just a moment here at the start of 2021, with Treasury yields finally busting out of long-held ranges to levels last seen in the early days of the pandemic. Most Wall Street analysts see yields gliding even higher, given the vaccine rollout, and the prospect of business reopenings and additional fiscal stimulus.

The threat of higher borrowing costs is already looming over risky assets, from U.S. shares to emerging-market securities. So far, the pace of increase doesn’t appear to be alarming Federal Reserve officials, but traders will be monitoring Chair Jerome Powell’s testimony to Congress next week for any sign that he’s troubled by steeper long-term borrowing costs. Barring any such hint, the market is left to ponder the extent to which the reflation trade will drive up yields.

“Before the pandemic, the 10-year yield was trading at about 1.6%, and if we are going to get back to what the economic situation was -- give or take -- back then, then there’s no reason why yields should be lower than that,” said Stephen Stanley, chief economist at Amherst Pierpont Securities.

He forecasts the 10-year yield will end the year at 2% -- a level last seen in August 2019 -- up from the almost one-year high of 1.36% reached this week.

Surging inflation expectations have been a key driver for 10-year yields, a trend that the Fed has helped fuel with its promise to keep policy rates ultra-low until consumer prices accelerate sustainably. Ten-year breakeven rates, a proxy for where investors see the annual inflation rate for the next decade, touched 2.26% this month, the highest since 2014.