Neither soaring inflation, nor high interest rates nor the resumption of student loan payments have put much of a dent in the seemingly unruffled U.S. economy.
Yet a recent jump in 10-year Treasury yields could be a tipping point, helping douse a remarkable growth spurt and possibly nudging the nation into a mild recession next year, some forecasters say.
How much did the economy grow in the third quarter?
The government on Thursday is expected to report that the economy grew at a robust 3.5% annual rate in the July to September quarter, fueled by strong consumer spending, according to economists surveyed by Wolters Kluwer Blue Chip Economic Indicators (up from solid 2%-plus gains the first half of the year). But growth is expected to slow to 0.7% in the current quarter and 1.1% for all of next year, the survey shows.
The surge in long-term rates could be a big reason for the pullback, analysts say. The economy also faces the effects of the renewed student loan repayments, a United Auto Workers strike, the possibility of a government shutdown and the cumulative effects of the Federal Reserve’s short-term rate hikes.
What is the current yield on the 10-year Treasury?
The 10-year bond topped 5% last week for the first time since 2007 – up from 3.2% in early April and 4.6% on October 9 — hammering the stock market and casting a veneer of gloom across the outlook. That’s because the 10-year note serves as a benchmark that has ripple effects on other types of consumer and business loans.
Higher long-term rates could push 30-year mortgage rates past 8%, further hobbling the housing market. Loftier rates also could discourage business investment, and hamper U.S. exports, among other impacts.
“It’s bad news for the economy,” says economist Matt Colyar of Moody’s Analytics. “It’s a major headwind.”
Federal Reserve Chair Jerome Powell stanched the bleeding last week by saying the bond’s rise is doing some of the Fed’s inflation-fighting work, making it less likely the central bank will have to raise short-term interest rates again. Since then, 10 year yields have dipped as low as 4.8% but rebounded to 4.9% Wednesday as the S&P 500 index fell 1.2% in mid-day trading.
The 10-year bond yield generally amounts to the average of short-term rates over the decade as well as the risk investors take by tying up their money for that long, which figures in the outlook for the economy and inflation.
Why has the 10-year Treasury gone up?
Economists cite several reasons for the surge:
∎ An economy that remains resilient despite 5.25 percentage points in Fed rate hikes since early last year, IS likely leading the Fed to keep its key rate higher for longer in 2024;
∎ Inflation that has stayed elevated – most recently hovering at 3.7% after falling from a peak of 9.1% last year – which could also mean the Fed keeps short-term rates elevated. Inflation prods bond investors to demand higher rates to keep pace with rising costs.
∎ A nearly $2 trillion federal deficit in fiscal 2023 and an even bigger projected gap in 2024 that could spawn more debt standoffs in Congress and force the federal government to issue more Treasury bonds. All else equal, the increased supply likely would lower their price and push up their yield.
Barclays economist Jonathan Barclays isn’t convinced that high long-term rates will be the final straw that undermines a resilient economy that continues to be buoyed by strong job and wage growth. Employers have been reluctant to lay off workers because of longstanding pandemic-related labor shortages.
“It should slow the economy,” he says. “The risk is that it doesn’t have the effect people think.”
Also, Millar says, if the economy weakens significantly, the Fed could cut rates sooner than expected, lowering 10-year yields and easing the financial strains,
Here’s how higher long-term rates could affect the economy:
Housing
High 10-year bond yields already have bumped 30-year mortgage rates to or near 8% for the first time since 2000, and additional rises could propel them further.
So far high mortgage rates have been a mixed bag for the housing market. They’ve hurt existing home sales by discouraging homeowners from selling because they don’t want to be saddled with much higher payments when they buy another house.
But the limited housing supplies have kept home prices from falling and led builders to put up more new homes, generating economic activity, Millar says. Colyar, however, worries that even higher mortgage rates would eventually dampen both new and existing home sales.
Business investment
Like mortgages, corporate bonds and other business loans track long-term Treasury rates.
Small businesses haven’t notably changed their capital spending plans, according to a September survey by the National Federation of Independent Business. But a growing share are saying their last loan was harder to obtain, more said financing was their top business problem and fewer say all their credit needs have been met, according to NFIB’s September survey.
If businesses struggle to get loans, that would mean less investment and hiring, Colyar says.
Exports
Higher Treasury rates make it more attractive for U.S. and foreign investors to put their money in U.S. bonds, increasing the value of the dollar. That makes it more expensive for overseas companies to buy goods from American manufacturers, hurting U.S. exports and dinging economic growth.
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The stock market
A 5% Treasury yield should prompt many investors to shift their money from stocks to bonds, lowering equity prices. A down market makes consumers who invest in stocks or mutual funds feel less wealthy, hurting their spending.
Every dollar decline in wealth reduces spending by about 5 cents, according to Moody’s. And consumer spending makes up about 70% of economic activity.
