INSIGHTS

HOW HIGH CAN WE GO?

Dori Levanoni
|
June 18, 2021

Folks have been concerned about rising yields (in particular, on the long end of the curve) for some time. Some of those fears have been realized, as we have seen the 10-year yield rise from its all-time low in early August 2020 (just above 0.5%) to nearly 1.7% recently.

But how high can yields go?

The FOMC has largely communicated that they don’t expect to tighten monetary policy, either by liquidity/balance sheet changes or short-term interest rate setting, for some time. So asking “how high can yields go?” essentially is the same as asking “how steep can the yield curve get?”

Switching to that question is a bit easier to study, since the steepness of the US Treasury yield curve is mathematically more tractable. For example, we can start by calculating the “slope” (10y – 3m yield difference) and showing it historically:

FIGURE 01 - US TREASURY 10Y VS 3M SLOPE
(September 1981 - June 2021)

US Treasury 10y vs 3m Slope

Sources: St. Louis Federal Reserve (FRED), First Quadrant, L.P.

Outside of that spike early on, the steepest the nominal yield curve ever got was a bit over 400bp. To go further back, we need to switch to the 1y bill for the short rate. It’s not quite as steep and it gets to only just over 3.5% at its peak, but the general shape is about the same:

FIGURE 02 - US TREASURY SLOPES
(September 1981 - June 2021)

US Treasury Slopes

Sources: St. Louis Federal Reserve (FRED), First Quadrant, L.P.

With that, we can look further back:

FIGURE 03 - US TREASURY 10Y VS 1Y SLOPE
(January 1962 - June 2021)

US Treasury 10y vs 1y Slope

Sources: St. Louis Federal Reserve (FRED), First Quadrant, L.P.

The difference gets to only just over 3.5% at its peak, and that’s in the more recent (1992 to present) period, so historical data supports that the steepest the 10y-3m likely ever got (or would have gotten) was around 400bp.

So, what can we learn from this exercise?

First, looking around the steepest points, we can see three (and a half) periods of notable steepening, and all occur starting when the slope goes negative and the Fed begins to cut rates:

1. Jul-1989 to Apr-1992 – Fed begins rate cutting on July 15th
2. Jan-2001 to Mar-2002 – Fed begins rate cutting on Jan 3rd
3. Feb-2007 to Oct-2008 – Fed begins rate cutting on Sep 18th
3.5 Sep-2019 to Present – Fed begins rate cutting on Aug 1st

Second, when the curve steepens, it tends to do so over a 12- to 18-month period.

Third, we’re perhaps only half as steep as the historical maximum and we’re around 18 months after the start of steepening.

Hence, using history as a guide, what we could say is that we’d expect to see the US 10-year yield max out at around 400bp (around 240bp above current levels), and if it’s going to do so, it will do so in the near future (before 2021 is over). If the Fed starts raising rates, though…all bets are off!

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© First Quadrant, L.P. 2021. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, L.P. only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

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