Coming into this year, we expected longer-maturity U.S. Treasury yields to rise, consistent with improving economic growth dynamics. That is indeed what we have seen, with the yield on the 10-year Treasury higher by 80 basis points (0.8%) year-to-date, and over 120 basis points (1.2%) since last year’s lows.
What we did not expect—at least not until the Democrats won two Senate seats in Georgia—was an additional nearly $2 trillion fiscal stimulus package on top of the super-accommodative Federal Reserve (Fed). The stronger economic growth outlook and resulting uptick in inflation expectations, which are key fundamental inputs into assessing Treasuries’ valuations, leads us to increase our year-end forecast for the 10-year Treasury yield to a range of 1.75% – 2.0%.
“The economic recovery continues to surprise to the upside and we think higher Treasury yields will be a result of that continued growth,” according to LPL Financial Chief Market Strategist Ryan Detrick.
Additionally, in our Outlook 2021: Powering Forward, we took a look at how Treasury yields did after large declines, which we certainly had as of the end of the first quarter in 2020. Here we are a year later and the outcome is well aligned with history. As seen in the LPL Research Chart of the Day, over the six prior large declines since 1990, the 10-year yield climbed an average of 0.92 percentage points after a large decline; this time the number was just a little higher at just above a full percentage point. What happened next historically? In the next quarter, yields continued to rise, on average, but fell over the following two quarters to get about back to a little above where they were after a year. If that holds true this time, it’s a good fit with our updated forecast range of 1.75–2.0%.
Yields may temporarily eclipse 2.0% in the short-term, as inflation readings pick up and economic data continues to show material improvements. However, we still believe there are structural headwinds to sustained, outsized inflation levels that should limit further sell-offs in Treasuries and bring yields back in-line with our fundamental assessment by year end (read more on our inflation views here). Moreover, given the continued search for income, yield levels significantly above 2.0% would likely represent an attractive entry point to both foreign and domestic investors, assuming no material changes to the growth and inflation outlook.
While we are updating our year-end Treasury yield forecast, our preference for less interest-rate sensitive fixed income investments has not changed. Additionally, we still believe an underweight to fixed income relative to targets within a diversified asset allocation makes sense at this time.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. U.S. Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. They are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy. All index and market data from FactSet and MarketWatch. This Research material was prepared by LPL Financial, LLC. Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.
- Not Insured by FDIC/NCUA or Any Other Government Agency
- Not Bank/Credit Union Guaranteed
- Not Bank/Credit Union Deposits or Obligations
- May Lose Value
For Public Use – Tracking # 1-05130279