Ever since the Federal Reserve started hinting it was planning to end its ultra-loose monetary policy, bond yields have been falling. That it happened in a booming economy with the highest inflation readings in nearly 40 years has taken a lot of investors and analysts by surprise. However, it’s a pattern that has occurred before, and may indicate that long-term bond yields already have peaked for this economic cycle.
In the past three rate-hike cycles (beginning in 1994, 1999 and 2015), 10-year Treasury yields posted interim highs six to 12 months prior to the initial rate hike by the Fed.
Ten-year yields have shown a pattern of declining well before the first Fed rate hike of a cycle
This market reaction reflects the power of the Fed’s signaling its policy intentions. The prospect of tighter monetary policy reduces expectations for growth and inflation down the road, which is supportive for long-term bonds. Consequently, Fed tightening cycles tend to be characterized by flattening yield curves—where short-term rates move up in tandem with Fed rate hikes while longer-term bond yields stabilize or fall. The Treasury yield curve has flattened sharply since the last Federal Open Market Committee (FOMC) meeting in September, when policymakers confirmed the Fed would begin tapering its bond purchases, a step toward reining in its loose policies.
Treasury yield curve, current vs the September FOMC meeting