We believe bond yield normalization has begun, but it’s coming at a time when the U.S. economy is still not normal. We think yields are eventually heading toward their historical averages, with assistance from the Federal Reserve (the Fed). How high might yields go? Based on projected real yield and inflation levels (under subpar economic recovery conditions), we think 4% represents the high end of the 10-year Treasury yield’s normalized level for the next 12 months. We’ve already touched 3%, after the May to September “Taper Tantrum.”
Read MacEwen’s full Q4 2013 CIO Insight:
How High Might Yields Go? Not Sky High, by Our Analysis
“We believe the Fed is seeking to normalize yields at a time when the U.S. economy is still not normal.”
We believe investors can prepare for higher yields by keeping their bond portfolio durations relatively short, choosing their sectors wisely, and holding their investments for at least the length of their portfolio durations so bonds have time to mature. Also, investors who think inflation and yields will be higher might want to consider short-duration inflation-indexed bonds and/or portfolios that use these securities.
- We believe the Fed wants to start tapering its $85 billion in monthly bond purchases as the U.S. economy shows signs of strengthening.
- However, we believe the Fed has run into two obstacles: 1) the “Taper Tantrum” triggered by taper talk (pushing the 10-year Treasury yield to 3% in early September), and 2) the economy appears weaker now than when the present level of bond purchases was started.
- In this environment, we believe 4% represents the high end of the 10-year Treasury yield’s “normalized” level for the next 12 months.
- We base this on a possible 2% real yield for 10-year Treasuries (from less than 0.5% now) plus 2% inflation (inflation has run below that level most of this year).
- Investors who think yields and inflation will be higher than this might want to consider short-duration inflation-protection products.
Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.
The opinions expressed are those of G. David MacEwen and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice.