Treasury yields are trending higher. Stocks won’t like it.

 Treasury yields are trending higher.  Stocks won't like it.
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It’s back to the future for interest rates.

The benchmark 10-year Treasury yield briefly broke above the 4.5% level last week, widely noted to be the highest level since 2007. That makes it seem like something unusual. In reality, it represented little more than a return to normal life.

This 4.5% yield represents the long-term average of US government debt, and by that we mean the really long-term yield, going back to 1790. Jim Reid, head of global core credit strategy at Deutsche Bank, is credited for this observation.

“In some ways, this could be seen as a concern, because we are now ‘just’ at normal historical levels, despite the fact that inflation remains high and record peacetime deficits are expected for the rest of your career, no matter how old you are.” “,” he captioned one of his always informative notes in the day planner.

“The good news is that at least value has returned. “It will be much harder for long-term investors to lose money in Treasuries now that it has been that way for most of the last decade in nominal terms and, to a lesser extent, in real terms,” he added.

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But this came after stunning losses in supposedly “riskless” government securities, some of which were selling for less than 50% of their face value. With a nod to the central banker’s Deadhead, what a long, strange trip it’s been – and a bad one for those who own the 1.25% Treasuries due May 15, 2050, which closed Thursday at 48.186, more less than half their original price just over Three years.

But the question remains: Are we there yet? While the Fed, as expected, kept its federal funds target unchanged, at 5.25% to 5.5%, at its policy meeting last week, it also confirmed that it intends to keep interest rates higher for longer.

As the aforementioned Fed Chairman, Jerome Powell, emphasized, policymakers will act cautiously. In terms of the Federal Open Market Committee’s updated summary of economic forecasts, that could mean another quarter-point increase in the federal funds target this year, to the midpoint of 5.6%. But for 2024, the median FOMC forecast now is for an overall rate cut of half a percentage point by the end of the year (presumably in quarter-point increments), to 5.1%, rather than a full point.

That’s based on economic forecasts that envision continued growth and continued easing of inflation with unemployment slightly higher than expected next year, a fortuitous combination that JPMorgan chief economist Bruce Kasman described as “aspirational.”

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Given short-term rates are in the 5% range through 2024, the 4.5% rate hit last week on the 10-year Treasury note does not appear to be its final destination. History shows that the federal funds rate and the 10-year Treasury rate tend to peak at about the same level, according to Jawad Mian, founder and managing editor at Stray Reflections, an independent global macro research and trade consultancy.

What is different this time is that the Fed’s previous quantitative easing reduced the so-called term premium (the extra return for holding longer maturities, which is similar to the equity risk premium for stocks) by perhaps a full percentage point. With the Fed reducing its holdings of Treasuries at the same time as the federal government faces $18.8 trillion in deficits over the next decade, the Congressional Budget Office estimates, the term premium should rise and lift yields, he wrote in a client note.

Chris Fearon, head of the technical and macro research team at Strategas, also sees 10-year Treasuries heading to 5.1%-5.2% on his charts after breaking above their previous peak of 4.36%. Moreover, he believes that the stock market has become uncomfortable with the level of interest rates.

Cyclical stocks stopped outperforming defensive names last month, he noted in a client note. And while


Standard & Poor’s 500 Index

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The equal-weighted S&P 500 remains well above its August lows and its 200-day moving average, supported by the Magnificent Seven big tech names, and the equal-weighted S&P 500 has broken below both marks.

Investors weaned on historically low interest rates now have to deal with money that no longer costs anything, or even less after accounting for inflation.

Write to Randall W. Forsyth at randall.forsyth@barrons.com

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