Long-term US yields are not falling

As US recession fears mount, short-term yields are falling, but not long-term ones

A key feature of global markets this year is upward pressure on longer-term yields. That’s not specific to the US, but - as I flagged in a recent post - is a global feature, with big increases in long-term yields in Japan and across Europe. This reflects in turn the sharp rise in debt during COVID, when budget deficits increased sharply and remain wide in many cases. The world is dealing with an oversupply of government debt and markets are demanding higher yields as a result.

Mounting US recession fears are now changing this picture a bit. Markets are pricing more Fed cuts, which is pulling down the front end of the US yield curve. However, it turns out that the back end of the yield curve isn’t falling nearly as much, a sign that the debt glut remains very much top of mind for markets.

The chart above shows government bond yields, where I use 10-, 20- and 30-year yields to construct a 10y10y forward (pink) and 10y20y forward (orange) yield. These yields are what markets price for the 10-year yield 10 and 20 years from now. It’s clear that the 2-year yield (black) is falling sharply, as expectations for more Fed cuts are building. The 10-year yield (blue) is also falling, but the 10y10y and 10y20y forward yields aren’t falling nearly as much. Looking at this from August 21 (the day before Chair Powell’s very dovish speech at Jackson Hole) to now, the 2-year yield is down 25 basis points, the 10-year is down 28 basis points, while the 10y10y forward is down only 22 basis points and the 10y20y forward is down only 16 basis points. This tells you that upward pressure on longer-term yields is still very much there, which US recession fears are only mitigating somewhat.

All this should give US policy makers pause. As I pointed out in a post a few weeks ago, pressuring the Fed to cut may not actually deliver lower yields. The reason that long-term yields are rising is reckless fiscal policy coupled with the fact that there’s a global debt overhang. The solution to that is to get US fiscal deficits back under control, not to lean on the Fed.