BIG NUMBER | 2.59%

What Are Higher Yields Really Telling Us? Context matters when rates are rising Bond yields are the hot topic of the week due to two events: The Fed meeting to determine whether to raise a key short-term interest rate in an effort to reduce inflation. The yield on the 10-year Treasury note—which influences borrowing costs across the economy— exceeding 5% for only the second time since 2007. Investors worry that rising bond yields will hinder the economic and corporate profit growth that helps fuel stock market gains. But in today’s environment, we believe that higher rates don’t necessarily mean restrictive rates, nor do they necessarily signal market stress.

Consider the 10-year Treasury’s real yield—the return above the market’s expected rate of inflation. That real yield is rising, currently at 2.59% ( see the chart ). Despite rising oil prices and concerns about fiscal deficits, much of the recent increase in Treasury yields has come from higher real yields as the economy remains resilient, rather than from higher inflation expectations.

What’s more, the increase in real yields has been largely concentrated in shorter-maturity bonds, whose yields are influenced mainly by expectations for Federal Reserve policy. Much of the recent rise in yields likely reflects investors repricing interest rates to higher, more typical levels after many years of historically abnormally low yields. The 10-year real yield shown in the chart reflects the market’s expected path for real short-term interest rates, plus compensation for holding longer-duration bonds. Both have been suppressed for many years and are now looking to be trending along a more traditional trajectory.

Ultimately, today’s real yields on government bonds may indicate that the economy can continue to thrive—and that businesses and investors can continue to spend, invest, and take risks—despite higher yields. Indeed, Fed Chair Kevin Warsh noted just a few weeks ago that “real consumer spending has been healthy” and that he “would be hard pressed to describe broad financial conditions as restrictive.” Yes, higher rates can put downward pressure on stock valuations. But context matters, and rising rates alongside the healthy growth we’re seeing today are very different from rising rates in a weakening economy.

The upshot: Instead of being a problem, we believe that today’s higher real yields are actually a result of economic strength—and a reflection of expectations for stronger future economic growth, a higher neutral policy rate, and more productive investment opportunities going forward.