For more than two years, I’ve been predicting higher yields. In December 2024, I caused controversy with an out-of-consensus view that the 10-year U.S. Treasury yield could possibly up to 6% (“The calm before the storm: the outlook for Treasury yields”). Back then, we were thinking about the global competition for capital among sovereigns, deteriorating fiscal policies, persistent inflation, and strong nominal growth. Sound familiar? My call was maybe a little early but very prescient of today’s environment.
After the sell-off in September and early October, 10-year Treasury yields got close to 5.4% and the 30-year yield nearly hit 5.7%. Later in October, the market recovered with yields falling again. The natural question is: “Have yields peaked?”
In a word—no, I don’t think yields have peaked.
Short positioning unwind drove October rally
The October decrease in yields was mostly about extreme short positioning being unwound. I have heard many suggest that the Treasury rally, which happened at the same time as equity volatility picked up, instead proved that Treasuries are again a “risk-off” hedge. Again, no, I don’t think that’s accurate. Or maybe more precisely, I’m going to need to see a lot more evidence—outside of a seasonally illiquid period—to believe that theory.
What has changed, however, is that I expect the Treasury yield curve to bear flatten as short maturities sell off more than longer bonds. Indeed, I would not be surprised to see the U.S. yield curve invert in the relatively near future.
Inflation is a more immediate concern than fiscal problems
To be clear, none of the fiscal challenges facing the long end of the U.S. curve have been fixed. Nor has the competition for capital gone away. However, a more immediate concern is inflation. Our proprietary indicators point to U.S. inflation running well above market expectations.
If our inflation forecast is accurate, the Federal Reserve will need to raise rates above the level that markets are currently pricing. Indeed, given that a few of the Fed’s usual interest rate transition mechanisms (such as the housing market) are structurally impaired, the Fed may potentially need to tighten significantly more than expected. That could lead to a curve inversion.
What would trigger a true peak in yields?
In my view, yields won’t truly peak until there is a recession.
There is a chance that the Fed could hike until something breaks—essentially an overtightening policy mistake. Another impetus for a peak in yields would be if developed-market governments take concrete steps toward fiscal responsibility. With yields on French government bonds climbing rapidly in October—to the point that some French corporate bonds yielded less than the sovereign—I’m watching to see if any other countries are learning the lesson.
While I am still somewhat bearish and see higher yields still to come in the longer term, it’s important to note that the fixed income asset class is substantially more attractive than it has been for a long period. It’s not just the level of yields—investors are also getting paid a decent amount over cash in some places. With this in mind, fixed income should slowly gain a bigger portion of the asset allocation budget.
