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Treasury yields rose to the highest levels since in the last 16 years, last week — with the 10-year rate nearing 5% on Thursday — after stronger-than-expected retail sales data stoked concerns that the Federal Reserve has more work to do in slowing inflation. Jerome Powell acknowledged that “inflation is still too high, and a few months of good data are only the beginning.”

The move higher can be attributed to a variety of factors: concerns of a higher for longer environment, an economy and labor market that hasn’t slowed, increasing government deficits, and an increase in the term premium or the extra yield investors demand as they worry about changing rates. The above considerations have ushered in a historic environment for bond markets and a trend that we don’t expect to change any time soon.

… Below portion from Yahoo Finance.

Christoph Schon, senior principal of applied research at market data and intelligence firm Qontigo, told Insider that a 10-year yield at 4.7%-5.1% looks appropriate relative to the current long-term inflation expectations, which stand at about 2.45%.

During the 1980s and 1990s, he explained, the 10-year Treasury yield was roughly two times inflation expectations, represented by the 10-year breakeven inflation rate. At the time, investors could expect real returns that matched the expected rate of inflation.

It took the dot-com bubble and 2008 financial crisis to shift this, however, and Treasurys became assets where investors could park cash while the stock market went through a long period of volatility.

“Stock and bond prices started to move in opposite directions, complementing each other depending on risk appetites,” Schon said.

He added that the recent surge in consumer prices with the pandemic and Russia’s invasion of Ukraine has meant stocks and bonds are correlated once again, with both assets selling off in tandem amid a sharp rise in interest rates.

“Our argument is that the current environment is more like the pre-2000s, in which Treasury bonds were an attractive alternative to equities, not just a safe haven in times of turmoil,” Schon said. “History suggests that the yield that investors would be looking for would be somewhere between 1.9 and 2.1 times inflation expectations. The current 10-year breakeven rate of 2.45% would therefore imply a corresponding nominal yield of between 4.7% and 5.1%.”

As for where the key bond yield heads next, history points to an answer there, too. There’s a less than 1% probability, he says, that the 10-year Treasury yield climbs above 5.5% barring any significant revision higher in inflation expectations.

In Thursday comments in New York, Fed chief Jerome Powell said policymakers will let the bond market volatility play out, and that rising yields have helped tighten financial conditions. Currently, the CME FedWatch Tool shows markets are pricing in 98% odds of no hike at the Fed’s November 1 meeting, and a 24% chance of a 25 basis point hike in December.

Other strategists have warned that there’s still a chance yields run higher. Phillip Colmar, global strategist at MRB Partners, predicted they could indeed breach 5.5% in 2024, and Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors, said a potential government shutdown in November could be an additional factor that pushes yields higher.

On Wednesday, Barclays strategists pointed out that the 10-year yield remains below the expected terminal rate for the Federal Reserve’s current hiking cycle, which is at odds with how tightening cycles usually end.

“The hurdle for a [bond] rally is still high,” the strategists said in a Wednesday note. “Despite data continuing to show a resilient economy, the consensus still expects it to slow very sharply over the coming quarters. Repeated misses beg the question whether the consensus has been overly confident about monetary policy being too tight. We argue that policy is barely tight and risks are skewed towards continued upside surprises.”