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Evening Brief – 05.17.23

It can be argued that the economic and inflationary patterns of the previous 30 years are likely to continue. High inflation and above-trend economic growth were produced by pandemic-related fiscal and monetary stimulus. Bond yields soared as a result, reaching highs not seen in fifteen years. They also ended the thirty-plus year downtrend.

But one may counter it on the grounds that current Treasury yields, which reflect the events of the last several years, are an anomaly rather than a new trend.

Investors buy bonds to boost their future purchasing power. Only by earning a yield higher than inflation can they reach that objective. Bond yields are thus mostly determined by economic activity and predicted inflation. As economic activity gravitates toward its natural rate of 1.5% to 2%, inflation and bond yields will likely follow.

Earning a long-term yield of 1.5% to 2% higher than the anticipated 10-year inflation rate will be a terrific bargain if pre-pandemic inflation levels return. Furthermore, even a small real yield that is positive (10-year yield less inflation) has been the exception rather than the rule over the past 15 years.

Despite obstacles that could prevent yields from falling (debt ceiling, post-debt ceiling issuance, QT), they can be overcome. Additionally, current yields are substantially higher than their recent lows if one assumes the economic and inflation trends of the past thirty years or more repeat. The 10-year yield was 0.50% just three years ago.

It’s vital to understand that not everyone who invests in long-term bonds holds them until they mature. Investors may sell the bonds, capitalize on the yield change, and reinvest the proceeds into a different asset class or even higher-yielding corporate bonds if rates recover to pre-pandemic levels.

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About Joe Palmisano

Joe Palmisano is Editorial Director for Connect Money, where he brings nearly three decades experience of market insights as a financial journalist, analyst and senior portfolio manager for leading financial publications, advisory firms, and hedge funds. In his role as Editorial Director, Joe is responsible for the selection of content and creation of daily business news covering the financial markets, including Alternative Assets, Direct Investment and Financial Advisory services. Before joining Connect Money, Joe was a financial journalist for the Wall Street Journal, regularly publishing feature stories and trend pieces on the foreign exchange, global fixed income and equity markets. Joe parlayed his experience as a financial journalist into roles as a Senior Research Analyst and Portfolio Manager, writing daily and weekly market analysis and managing a FX and US equity portfolio. Joe was also a contributing writer for industry magazines and publications, including SFO Magazine and the CMT Association. Joe earned a B.S.B.A. in Finance from The American University. He holds the Chartered Market Technician (CMT) designation and is a member of the CFA Institute.