by Lawrence Gillum, Chief Fixed Income Strategist, LPL Research
To say the U.S. economy has been difficult to read is an understatement. From generationally high inflation and interest rates to concerns about the labor market, it’s no wonder consumers are unsure about the overall health of the economy. In fact, 59% of Americans believe that the U.S. is currently in a recession, according to a recent survey of 2,000 adults by Affirm in June. Conversely, prominent economists have recently downgraded the probability of a recession over the next 12 months to around 15%, which is the average probability of recession in any given year. But, after what looks like a temporary growth scare over the summer months, economic growth data has been coming in generally better than expected lately, which has helped push Treasury yields higher.
As we discussed in a recent blog (It’s What’s Priced In That Matters), markets are forward-looking and tend to adjust based upon expectations. However, given the unpredictable nature of economic data, consensus expectations may be wrong at times, which causes another market adjustment. So, after hovering around the lowest levels since 2015, the Bloomberg Economic Surprise Index has been trending higher lately, reflecting economic data that has been, in general, better than consensus expectations. And since Treasury yields have fallen recently alongside negative economic surprises, it isn’t surprising that yields are now moving higher given the better economic data and as fewer Federal Reserve (Fed) rate cuts get priced into markets.
Treasury Yields are Higher on Better-Than-Expected Economic Data
Source: LPL Research, Bloomberg 10/15/24
Disclosures: All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.
So, what’s next? History shows that without signs of recession, intermediate and longer-term yields tend to drift higher, particularly as the Treasury yield curve further steepens. Our base case remains no recession this year and our year-end target for the 10-year Treasury yield is 3.75%–4.25%. So, while yields may move slightly higher from current levels, we still think we are past peak Treasury yields for this cycle.
But, if the economy, particularly the labor market, cools more than expected or if geopolitical events cause the Fed to accelerate rate cuts more than what is priced in, Treasury yields will likely fall. Historically, fixed income returns have come primarily from the income component, and with income levels still relatively attractive, we think clipping coupons is still an attractive strategy, especially versus cash.
