The yield on the standard 30-year U.S. Treasury bond rose to 5% during today’s trading, reaching this level for the first time since April. This increase comes amidst market focus on economic growth and future inflation expectations, overshadowing the effects of Moody's recent decision to downgrade the U.S. credit rating.
Analyst Giuseppe Dell'Aquila believes that Moody's downgrade does not represent a significant event, given that the agencies Standard & Poor’s and Fitch had previously taken similar actions in 2011 and 2023, respectively. He points out that the main drivers of long-term yields in advanced economies are future central bank policies and inflation expectations.
Dell'Aquila explains that the persistence of long-term Treasury yields in the range of 4% to 5% primarily reflects growth-supportive fiscal policies and the Federal Reserve keeping interest rates elevated for longer periods. He adds that if the Federal Reserve unexpectedly raises interest rates, possibly leading to a recession, long-term yields would quickly drop below 4%, and no one would pay much attention to Moody's downgrade in that scenario.
The analyst emphasizes that the upward trend in yields remains the most likely scenario at present, with rising inflation risks. As markets price in improved economic conditions, economic activity is likely to accelerate, which could lead to inflationary pressures. The Federal Reserve faces a delicate situation, as any cut in interest rates now could exacerbate inflation concerns and push long-term yields to higher levels.
Additionally, Dell'Aquila noted the continued rise in consumer inflation expectations according to last Friday’s University of Michigan survey, which was the main catalyst for the rise in yields before Moody's announcement of the downgrade. Despite potential doubts regarding the accuracy of the University of Michigan survey, the Federal Reserve's failure to achieve its inflation target for nearly five years may pose risks to inflation expectations stability at some point, necessitating an open approach toward this data.
