It would make sense for the bond market to take a breather here and digest a little. But the dynamics are in place for yields to rise further.

By Wolf Richter for WOLF STREET.

The 20-year Treasury yield rose by 17 basis points during the week, and by 37 basis points since Warsh’s Jackson Hole speech on August 28, to 5.55% on Friday, the highest since June 2004, and higher than the 30-year Treasury yield (5.50%). During the day, the 20-year yield had traded as high as 5.59%.

At the already lumpy 20-year Treasury auction on September 15, the government had to pay a yield of 5.42% to sell all $13 billion of bonds. That was the highest auction yield since the re-introduction of the 20-year bond in 2020. And it got lumpier still in the secondary market.

During the Fed’s maximum interest-rate repression in the spring and summer of 2020, when it purchased over $3 trillion of securities to force down long-term interest rates and inflate asset prices, the 20-year yield was at around 1.0%. Rising yields mean lower bond prices for existing holders, and bonds purchased at auction at the time have lost roughly half their value in the secondary market. And ever since then, courageous investors, trying to lock in those yields as they rose, have caught falling knives.

For some bond fence-sitters, a 20-year yield north of 5.5% is starting to look tempting, and some have come off the fence and bought, but not enough of them to push the yield back down, and the yield continued to rise during the week.

That’s the function of yield; it creates demand.

The 30-year Treasury yield rose by 15 basis points during the week and by 30 basis points since Warsh’s Jackson Hole speech, to 5.50%, the highest since May 2004.

The chart below shows the last 25 years of the 40-year bond bull market when yields kept zigzagging lower through mid-2020, and the first six years of the bond bear market.

Bloomberg’s Markets Pulse survey of 173 macroeconomic and market participants revealed today that over 50% of them expect the 30-year yield to be higher than 6% by the end of 2026.

Why buy now if you think you can get a 6%+ yield in a few months? This would be the highest yield since the roaring Dotcom Bubble year 1999. Those fence sitters are going to stay on their fence.

Why those yields? Long-term yields have surged to two-decade highs, the costs of borrowing have surged, and mortgage rates have surged, and that should have put a damper on the economy and inflation, but the economy isn’t slowing down, on the contrary. Corporate borrowing has ballooned despite the higher costs of borrowing as the historic AI boom needs to be funded. And this debt issuance is competing in the bond market with Treasury debt for investors. And inflation is accelerating amid this historic infrastructure investment boom, a massive geopolitical mess, very high energy costs, a tight labor market with labor shortages in some special areas, solid consumer spending growth, and reckless fiscal policies with deficits running at 6% of GDP despite the strong economy.

So part of the story of those bond yields is economic growth. Not adjusted for inflation, “nominal” or “current-dollar” GDP grew by 8.1% annualized in Q2.

Just on Friday, the August data was released for orders at US manufacturers of “core capital goods,” which are an indication of business investment. They soared by 14% year-over-year, driven by the AI infrastructure investment boom (details and more charts here):

Another part of the story is inflation, even if the bond market is still in partial denial about it. Inflation in the overall economy, faced by all participants – including consumers, businesses, and governments – as tracked by the GDP deflator spiked by 6.4% in Q2 from Q1 annualized, and by 4.4% year-over-year.

We’re looking straight at the beginning of the second wave of inflation in the overall economy. This is nothing to be trifled with:

Another part of the story is huge demand from Corporate America for funding the AI investment boom via debt issuance. Those AI bonds pay higher yields but come with much higher risks than Treasuries. And they’re putting pressure on the Treasury market.

And another part of the story is the ridiculously huge amount that the government needs to borrow to fund its ongoing deficits. The government has been adding $1 trillion to its Treasury debt every three to five months, and that $1 trillion needs to be enticed from investors with higher yields.

But wait a minute… Those 5.5% long-term yields just take the bond market back to the decades before the Fed’s interest rate repression and QE that started with the Financial Crisis.

In the second half of the 1990s, the economy was strong, the Dotcom Boom reigned, stocks were soaring, inflation in the overall economy was a lot lower than today (GDP deflator), Treasury yields were higher than today, the Fed’s policy rates were much higher than today, mortgage rates were between 7% and 9%, the labor market was tight, and unemployment was low.

The US economy can boom with higher yields. We’re seeing that now. And that’s part of the Fed’s problem. But now inflation is also booming.

Yields have come up a long way fairly quickly, and I expect buyers to come out in larger numbers at these yields, and take bigger bites, and it would make sense for the bond market to take a breather here.

But the dynamics are all there for yields to go higher still, and the expectation revealed in the Bloomberg poll of the 30-year yield to go over 6% by year-end does not sound unreasonable to this observer.

The 10-year Treasury yield rose by 16 basis points during the week and by 50 basis points since Warsh’s speech, to 5.17%, having traded as high as 5.23% on Friday intraday.

Since the end of February, it has soared by 120 basis points. But beyond the era of the Fed’s interest rate repression, beyond the era of QE and ZIRP, those 10-year yields are not high:

The average 30-year fixed mortgage rate rose on Friday to 7.5%, according to the daily measure by Mortgage News Daily, but this is not unheard-of territory.

Mortgage rates exceeded that level in April 2024, and before then, from late September through early November 2023, and before then, for most of the decades before the Fed’s interest rate repression.

Mortgage rates track long-term Treasury market yields, but are higher. And the same dynamics that drive up long-term Treasury yields also drive up mortgage rates.

7%-plus mortgage rates prevailed in the 1990s. In the prior decades, rates were much higher, with double-digit mortgage rates being quite common between 1979 and 1991.

Those higher rates did not freeze up the housing market back then. What’s freezing up the housing market now are the too-high prices, following the price explosion from mid-2020 to mid-2022.

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