A Wall Street veteran has warned that there is still room for the yield on the 10-year U.S. Treasury bond to rise, which could signal an imminent return to normalcy in the yield curve. However, this may not necessarily be a positive development.
Market forecaster Jim Bianco stated that as the yield curve is about to un-invert (returning to normal from an inverted state), there is nothing that can prevent the yield on the 10-year U.S. Treasury note from continuing to soar above 5%.
The president of Bianco Research, a seasoned Wall Street figure, pointed out that the recent surge in bond yields saw the yield on the 10-year U.S. Treasury note reach 5% on Monday, a threshold it has not breached since 2007.
Since then, bond yields have retreated somewhat, with the 10-year Treasury note trading around 4.85% on Tuesday. However, Bianco indicated that another round of spikes could occur as market concerns about rates being "higher for longer" persist.
In an interview, Bianco said regarding the yield on the 10-year Treasury note, "If we are going to fully normalize the yield curve, I believe we are destined to do so, or are heading in that direction, and ultimately it (the yield on the 10-year Treasury note) will reach at least 5.5%."
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The yield on the two-year U.S. Treasury note has exceeded that of the 10-year U.S. Treasury note for over a year, which is a classic recession signal that flashes when investors believe a mid-term economic downturn is on the horizon.
The normalization of the yield curve implies that investors are altering their expectations to believe that long-term interest rates will remain elevated.
This is largely due to the Federal Reserve's vow to maintain a hardline stance on inflation by keeping high interest rates in the economy.
According to the FedWatch tool from the Chicago Mercantile Exchange (CME), investors currently estimate a 98% likelihood that interest rates will remain above 4% by the end of 2024, which could also keep bond yields high.
Some commentators have put forward arguments for rate cuts in 2024, including the possibility that higher rates could over-tighten the economy, pushing it into a recession.But Bianco said that interest rates have not actually tightened to the extent of "damaging the economy," with a few indicators showing that economic activity remains strong. Economists at the Atlanta Federal Reserve expect the US GDP to have grown by 5.4% in the past quarter. At the same time, the labor market is still hot, with the US economy adding a surge of 336,000 jobs in the last quarter.
"We are not really punishing the economy. That's why I think there is room for yields to rise," said Bianco.
Bianco added that as the US seeks to issue more long-term Treasury bonds, long-term yields could also be pushed higher. Meanwhile, as the largest foreign holder of US Treasury bonds globally, the Bank of Japan may also reduce its holdings of US Treasury bonds because it may tighten monetary policy, which could also push up yields.
Although the US economy has been resilient so far, some experts point out that the yield curve between the two-year and 10-year Treasury bonds usually shifts from inversion to normal a few months before a recession, suggesting that a recession may be around the corner.