The yield on 10-year Treasury bonds continues to move above 1%, reaching 1.15% last week for the first time since the end of last February, when the severity of the coronavirus outbreak was becoming apparent.
The increase in long-term interest rates can be interpreted as a sign of confidence in the economy’s potential.
The increase in long-term interest rates can be interpreted as an encouraging sign of confidence in the economy’s potential, and in the competence of the monetary and fiscal authorities to address the downturn.
The Federal Reserve has said that it will maintain its policies of keeping short-term rates at the zero bound for as long as necessary, while pressuring long-term rates lower through the purchases of securities.
And there is growing evidence of a coordinated government response to the pandemic and to the lack of demand in the economy, both of which are requisites for a full economic recovery.
That translates into diminished expectations for the path of short-term interest rates and a diminished risk of deflation, as captured by the increase in the term premium required for holding 10-year bonds.
The sum of those two components adds up to the 1.15% yield on the 10-year Treasury as shown in the analysis by economists at the Federal Reserve Bank of New York.
The term premium had been declining since 2017 as the disruption to global trade and the subsequent global manufacturing recession resulted in a loss of confidence in the economy’s potential.
The presence of a negative term premium indicates compensation for the risk of deflation, which occurs when economic demand is insufficient and growth becomes unsustainable.
The term premium bottomed out in the third quarter last year when signs of a vaccine and economic growth became apparent. We expect that trend to continue as the pandemic relief programs take hold and as vaccinations become more readily available.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
