By now, you know that the 10-year U.S. Treasury yield breached 3 percent for the first time in weeks. It climbed as high as 3.03 percent on Tuesday, a level not seen since May, when it touched a seven-year high.
The attention heaped on the global borrowing benchmark is warranted, of course. But for fixed-income investors, a crucial piece of context is what’s happening with shorter-term yields, which also seem to be on a glide path toward 3 percent.
Seven-year Treasuries actually broke through that mark in May, hitting 3.08 percent. The five-year yield didn’t quite get there, topping off at 2.95 percent (it’s at 2.92 percent now). Two- and three-year Treasuries set new 10-year highs this week, at 2.79 percent and 2.86 percent, respectively.
This may seem like a long way of saying that the U.S. yield curve is extremely flat. But it’s instructive to break out each maturity because of their respective total returns this year, and the prospect for further gains in the weeks and months ahead. Ultimately, it comes down to a dilemma over duration, which measures sensitivity to changes in interest rates.
Take two-year Treasuries. Their yield has increased steadily this year, climbing about 90 basis points. Given that prices and yields move in opposite directions, those notes would seem like a losing wager.
That analysis would be wrong. In fact, two-year Treasuries have eked out a 0.14 percent return year-to-date, according to ICE Bank of America Merrill Lynch data. Granted, that’s not much – but it’s better than taking losses like every longer maturity. Though 30-year yields are below their 2018 highs, only rising about 40 basis points this year, the debt has still declined by 5.6 percent. Even if this isn’t a full-fledged bond bear market, long duration has stung investors.
But now, several rate hikes into the Federal Reserve’s tightening cycle, the outlook gets tricky. The central bank is set to raise interest rates again next week, then possibly again in December. A further two increases are likely next year. After two more hikes, the fed funds rate would have an upper bound of 2.5 percent. After four, it would be 3 percent. To most policy makers, the neutral, long-term rate is between 2.75 percent and 3 percent.