The Fed vs. the Bond Market

The economy is bound to eventually reach a point where it can no longer tolerate the interest rates required to keep inflation and debt under control, and some of the loudest warnings are coming from the bond market.

The benchmark 10-year Treasury yield recently climbed above 5.3%, reaching levels not seen since 2002. Even more striking, this surge occurred as evidence was building up of a weakening labor market, not because investors suddenly became convinced that the American economy was entering a new era of extraordinary real growth.

A rising 10-year yield is normally associated with a healthy economy. Strong growth can produce stronger demand for capital, while rising inflation expectations can lead investors to demand higher nominal returns. But when long-term yields continue rising while economic data deteriorate, the interpretation changes.

Instead of “America’s economy is getting stronger,” the bond market is saying, “America is becoming more expensive to finance.”