US Treasury Secretary Janet Yellen delivers remarks on the Inflation Reduction Act on 2 August 2023. AFP.
US Treasury Secretary Janet Yellen delivers remarks on the Inflation Reduction Act on 2 August 2023. AFP.
We have seen a recent surge in long-dated UST yields, with the 10Y yield rising from 3.3% in April to as high as 4.2% and similarly with the 30Y yield rising from 3.5% to 4.3% (Exhibit 1).
Exhibit 1: Surge in 10Y and 30Y UST yields
Sources: Bank of Singapore, Bloomberg, data as at 15 Aug 2023
The rise in US yields has been driven by three key factors.
Firstly, US economy and labour market have been more resilient than anticipated over the year to date. As the market assesses higher odds that a recession is delayed or averted, the scenario that the US Federal Reserve (Fed) will need to keep rates higher for longer appears more likely.
Secondly, the US Department of the Treasury (US Treasury) recently indicated that they plan to increase the issuance of long-dated UST in 4Q23. An increased supply of long-dated UST is a negative factor for prices. Moreover, this supply headwind is not likely to improve over the near term given that:
- the US Treasury is near its recommended proportional limit of T-bills issuance and thus will need to increase the proportion of long-dated UST issuance ahead, and;
- the US government is running a significant fiscal deficit in the absence of a recession now, and in a recession scenario ahead will need to further raise spending to counter negative growth.
Lastly, recent events such as the Bank of Japan’s (BoJ) adjustment of its yield curve control (YCC) policy, Fitch’s downgrade of the US credit rating, and the rebound in crude oil prices all contributed, in various degrees, to driving long-dated UST yields higher.
In particular, the rebound in crude oil prices to almost year-to-date highs is a negative factor for the US inflation picture, especially if we consider that the US strategic petroleum reserve is drawn down to a multi-decade low. As the odds of sticky inflation rises, so does the likelihood that the Fed needs to keep rates high to combat inflation.
Exhibit 2: Crude oil prices rebounded to near year-to-date highs in August
Sources: Bank of Singapore, Bloomberg
Given the above forces, long-dated UST yields could further overshoot to the upside before signs of a recession become clearer. Ultimately, our base case expectation is that a US recession would start sometime in 4H23 or 1H24, which will bring UST yields down as the Fed is expected to cut rates in this scenario to counter negative growth.
As asset prices are heavily influenced by UST yields which form the risk-free rate, we cannot rule out the risk that overshooting UST yields in the meantime could set off market volatility.
Moreover, the sharp year-to-date rally in US equities has been mostly driven by higher price-to-earnings (P/E) multiples, while long-dated UST yields have also risen over the same period. This is unusual as P/E multiples and UST yields tend to have an inverse relationship over the long term. Therefore, the recent divergence between equity P/E multiples and UST yields is likely unsustainable.
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