Bill Dudley strongly suspects that the bond bull market that began in the early 1980s is over
My forecast broke the 10-year Treasury yield down into three constituent estimates.
First, there’s r*, the “neutral” short-term interest rate that the Federal Reserve would set if it wanted to neither hinder nor stimulate growth. I put this at 1%.
Then, there’s the average long-term inflation rate: 2.5%.
Finally, I estimated the term premium, the added yield that investors will require to compensate for the risks of longer-term lending: 1%.
From there, the arithmetic was simple: 1% + 2.5% + 1% = a target yield of 4.5%.
Since then, the 10-year yield has risen significantly, to about 4.3%. But I’m not taking a victory lap.
My evaluation focused on longer-term secular trends. I certainly didn’t anticipate that yields would immediately shoot up.
First, the economy’s strength amid much higher interest rates suggests that the neutral rate is higher than previously believed.
I expect officials to keep revising their estimates of r* upwards
Second, the US government’s fiscal health keeps deteriorating
The bond term premium is the hardest part to forecast. Prior to the 2008 financial crisis, it averaged about 100 basis points.
I don’t pretend to know how bond yields will move in the near future. But for the longer term the paradigm has shifted, and higher yields are back.
Bill Dudley Bloomberg 22 August 2023
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