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The Days of Low Treasury Yields Are Numbered

Bloomberg Opinion  | Wed, May 12, 2021

by William C. Dudley

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The 10-year U.S. Treasury note is part of the foundation of global finance. Its yield helps determine the cost of mortgages, the value of U.S. stocks and how much the U.S. government must pay to service its growing debt. 

I think markets are severely underestimating how much that yield is likely to rise in coming years. 

Right now, the 10-year Treasury yields about 1.6%. That’s unsustainably low, for two main reasons. First, as I argued in a recent column, the Federal Reserve is likely to raise short-term interest rates far beyond that level. Second, the added yield the government must pay to borrow for longer periods — known as the term premium — is likely to increase, too. Let’s take these points in order. 

The yield of any 10-year security must incorporate expectations for shorter-term rates over the same period. So where does the Fed, which controls short-term rates, think they’re headed? In their latest projections, officials estimated that over the long run, the federal funds rate consistent with the central bank’s 2% inflation target would be somewhere between 2% and 3%. The median estimate was 2.5%. If they’re right, this should be the floor for longer-term Treasury yields. Why tie up money for 10 years if you can get the same return by lending for much shorter periods? 

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