The 10-year Treasury yield briefly touched the 2.5% mark on Friday, March 25, 2022. It was a week of rising yields for all but the really short-term ones. The one-month yield fell slightly.
The 10-year yield is still incredibly low by historical standards. It is even more incredible when you think that price inflation, according to the government’s own statistics, is running at 7.9% annually.
If you invest in a 10-year bond paying 2.5%, you are losing about 5.5% every year if price inflation stays where it is. Also, don’t forget that you still have to pay taxes on that 2.5% “gain”.
It is also interesting to note that some of the yield curve is flattening, and even slightly inverted.
As of this writing, the 10-year yield is slightly below the 7-year, 5-year, and 3-year yields. The 2-year yield is still slightly below the 10-year yield, which some people look at as a recession indicator.
When it comes to an inverted yield curve, I prefer to look at the 10-year yield vs. the 3-month yield. I think that is a much stronger predictor of a recession.
Still, we can learn a lot by looking at what bond investors are doing right now. If price inflation is near 8%, why would anyone invest in something yielding just above 2% per year?
One of the answers to that is that a safe 2% return (nominally) is better than nothing. It is better to lose 6% than 8%. And if you invest in other assets, you could end up losing more than the 8% in the depreciating currency if the prices of the assets go down.
Someone may also invest in bonds because they expect rates to fall, which will drive up the price of the bonds.
There is also a question of why someone would by a Treasury security for 5 years when you can get about the same rate for 3 years. Why lock yourself in?
The answer is that someone might expect the rate to be lower 3 years from now.
The spread from the 2-year yield to the 30-year yield is less than 50 basis points (half of a percent). In this range, the yield curve is pretty flat. It is even slightly inverted in spots.
What this indicates to me is that bond investors are not expecting the high price inflation to be sustained. They see a recession coming sometime in the not-too-distant future and for prices to come down, or at least to stop rising so fast.
This isn’t to say that the bond market has to be right. I do think the bond market tends to be smarter than the stock market. (I understand that markets themselves aren’t smart, but you know what I mean.)
If bond investors expected 7 or 8 percent price inflation to continue for several years into the future, I don’t think they would be accepting yields just above 2%. It’s not that yields have to rise to the level of price inflation, but there would certainly be a tendency to demand higher rates of interest.
In addition, while the price of gold has been holding above $1,900 per ounce, it hasn’t exactly exploded in price. So the gold market – or the lack of a gold market – is also indicating that price inflation is not a big worry down the line.
Again, this isn’t to say that the bond market and gold market can tell us everything we need to know. There are certainly a lot of distortions out there. It also complicates things that the Fed has still been buying some Treasury securities, even if at a slower pace.
I think libertarians have been vindicated just a little bit in warning about reckless government spending and Federal Reserve monetary inflation. We are now clearly seeing some of the consequences of those bad policies.
At the same time, it doesn’t mean higher price inflation will continue. The Fed is finally winding down its monetary inflation, at least for now.
If the bond market is right, then we shouldn’t worry too much about higher price inflation a few years from now. As the yield curve flattens, we should worry about a severe recession, which will actually relieve the price inflation, at least in the short run.