The yield on 10-year Treasury bonds has moved to 1.55%, within 50 basis points of already low pre-pandemic rates. While anything near 1.60% is better than the roughly 0.60% observed last year, we expect the yield to rise to 1.9% at the end of the year as the economy reopens and the nearly $6 trillion in fiscal aid works its way through the economy.
Changes in real yields
The real (inflation-adjusted) yield on 10-year Treasury bonds is now negative at all maturities. The goal of the monetary policy is to facilitate investments that will be paid back in inflation-depreciated dollars.
Interest rate trends
Confidence in the recovery is reducing the perceived risk of economic collapse and deflation. At the same time, guidance from the Federal Reserve consistently suggests low-for-long money market rates. The result is an economy that can support higher long-term interest rates, while monetary policy pressures short-term bond yields lower – that is, a steepening yield curve.
The inflation rate is moving higher, a welcome sign of increased demand and economic activity. The Fed has said that because inflation and demand have been abnormally low for so long, it will tolerate inflation rates of greater than its 2% target before it raises rates.
When will the economy support higher interest rates?
Because of the structural shifts in the economy – automation, the advent of the global supply chain and the adoption of inflation-targeting by central banks – the expected return on investment has trended lower, particularly in the aftermath of the Global Financial Crisis and the Great Recession. The economy can arguably no longer support the high real, or inflation-adjusted, rates of return in earlier decades.
The long-term decline of growth in U.S. gross domestic product suggests the need for another moonshot. The U.S. needs to create the foundation for the next economy, both in physical terms – with traditional structural improvements such as rebuilding the energy grid – and in intellectual terms, by addressing the deficiencies in education and health of the labor force. This is why the major debate in policy space right now is the efficacy of a major infrastructure spending plan.
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