There’s been plenty of attention on interest rates this past week. That focus is only going to intensify as we count down to the Federal Reserve’s next meeting in a couple of weeks – especially after Fed Chair Kevin Warsh’s hawkish comments at Jackson Hole on Friday.
Markets are now pricing in around a two-thirds chance that the Fed will hike rates by 0.25% on September 16. But there’s another interest rate I’m watching even more closely.
The U.S. 10-year Treasury yield recently pushed up to 4.78% – its highest level since January 2025. Meanwhile, the 30-year Treasury yield has climbed back above 5.25%. Its 5.34% peak last month was its highest level since June 2007. Those are significant levels.
While the Fed controls the overnight Federal funds rate, it doesn’t directly control longer-term Treasury yields. While policymakers can influence them, ultimately those yields are determined by the bond market.
And right now, the bond market is sending us a message that investors shouldn’t ignore…
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On August 19, the U.S. Treasury announced that it would at least double its buybacks of longer-dated bonds. Treasury said that the move was designed to improve liquidity in those older securities.
However, some in the market interpreted it as an attempt to lower longer-term yields. And you can understand why.
The U.S. government has an enormous amount of debt that continually needs to be refinanced. As older, lower-yielding bonds mature, the government has to issue replacement debt at substantially higher rates. That means the government’s interest bill increases.
Buying bonds increases demand, which typically pushes their prices higher. And because bond prices and yields move in opposite directions, that puts downward pressure on yields.
Yet despite initially falling after the Treasury’s buyback announcement, 10-year yields have reclaimed that lost ground and are pushing higher. And that highlights an important point.
The government can influence the Treasury market around the edges. But it can’t directly control where long-term yields trade.
Ultimately, yields reflect investors’ expectations around inflation, economic growth, future Fed policy, and the size and trajectory of government debt.
And when those yields change, the effects permeate right across the economy…
When 10-year Treasury yields rise, borrowing costs throughout the economy typically increase too.
That’s not just mortgage rates but also things like corporate bonds. They’re usually priced at a premium to Treasurys. That means that the cost of borrowing typically rises for companies too.
Higher yields can also have an impact on how investors value stocks – especially those priced for strong growth. The higher the rate used to discount those future profits, the lower their present value becomes.
That’s particularly relevant right now with the enormous valuations placed on AI-themed stocks.
If borrowing costs increase while a higher discount rate reduces the present value of expected future profits, those stocks could get squeezed from both directions.
But there’s another major consideration too.
When Treasury yields were sitting around just 1% or 2%, investors looking for decent returns had relatively few alternatives to stocks. But when U.S. government bonds are yielding close to 5%, the equation starts to change. Stocks need to offer a sufficiently attractive potential return for the additional risk investors are taking on.
So far, stocks have handled the rise in longer-term yields reasonably well. But if those yields keep rising, the pressure on stocks could continue to build.
That’s why I’m watching the 10-year just as closely as what the Fed does later this month.
Because ultimately, a potential 0.25% rate hike is only part of the story. What happens further out on the yield curve could prove much more important for stocks.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
