Scott Solomon, Co-Portfolio Manager for Dynamic Global Bonds Strategy at T. Rowe Price shares his views on the rising U.S. 10-year Treasury yield and its implications as follows:
During past economic cycles, we often observe a convergence between the 10-year Treasury yield and the terminal rates set by the Federal Reserve (Fed). Typically, they come quite close to each other. In the current cycle, the terminal rate is expected to reach at least five and a half percent, regardless of a potential rate hike in November.
The 10-year Treasury yield is not considered sufficiently restrictive to effectively slow down inflation in the United States. This is because so much of the US economy, including borrowing and lending, is tied to fixed interest rates, which are predominantly influenced by the 10-year Treasury yield.
Unlike previous cycles, the Fed’s focus on hiking rates is primarily driven by the need to address inflation rather than solely aiming to slow down growth. Consequently, there is increased volatility in the bond market, and it’s important for bond managers to have sufficient flexibility and actively manage duration.
Also read: Lessons Learned From the ‘Higher for Longer’ Period of 2006-07
I think the biggest risk that US economy is facing at present is whether liquidity mismatches will translate into a hard landing for the US economy. Typically, hard landings occur when not only lower-rated high-yield companies, but also investment-grade companies, experience defaults or severe downgrades to high-yield status. This triggers credit cycles rolling over and can lead the US into a deep recession, as we witnessed in 2015. However, the current situation does not indicate a significant default cycle among investment-grade companies as they have strong balance sheets and ample liquidity.
