The 10-year hits 5%. Why now?

The ten-year US Treasury yield touched 4.99 per cent on 19 October, within a whisker of 5.0 per cent for the first time since July 2007. The speed of the rise has shocked investors who spent a decade getting used to rates near zero. Break the move into its parts and the cause becomes clear.

Three pieces of a yield

A long bond yield can be split in two ways. One divides it into expected inflation, measured by breakeven rates on inflation-linked bonds, and the real yield investors demand on top. The other divides it into the average short-term interest rate expected over the life of the bond and a term premium, the extra return investors want for locking money away for a decade instead of rolling over short-term bills. Together they give a three-way view: inflation, expected policy and the price of time.

Each piece tells a different story about who is worried and why. If breakevens were driving yields, the market would be doubting the Federal Reserve's commitment to its 2 per cent target. If expected policy rates were driving them, the market would be betting on further increases. A rise in the term premium means investors are demanding more pay for the risk and quantity of the bonds themselves.

Not an inflation scare

Expected inflation has stayed close to 2.3 per cent, and expectations for short-term policy rates have actually eased. All of the rise in ten-year yields has come from a jump in the term premium and in real yields. Investors want far more pay for holding long-dated bonds, for lending to a government with loose finances, and for the extra supply as central banks shrink their balance sheets.

The Fed's own signals fit this reading. It held its policy rate at 5.25 to 5.50 per cent in September, and several officials have since said that the rise in long-term yields tightens financial conditions and may reduce the need for further increases. Markets have taken the hint and priced out much of the chance of another hike. If the long end were merely echoing policy, it would have fallen as those expectations softened. It rose instead.

What is driving the premium

Three forces are pushing the term premium up at once. The first is supply: the Treasury raised the size of its long-dated auctions in August for the first time since 2021, and the federal deficit remains large even with unemployment below 4 per cent. The second is the loss of price-insensitive buyers. The Fed is letting up to $60 billion of Treasuries a month run off its balance sheet, American banks are shrinking their bond holdings after the losses exposed by Silicon Valley Bank's collapse in March, and foreign official holders are adding little. The third is uncertainty. After two years in which inflation and policy both surprised, investors are less willing to assume that the path of rates can be forecast with confidence.

Politics has added a fourth irritant. Fitch downgraded America's credit rating in August, and the House of Representatives has been without a Speaker since McCarthy's removal on 3 October, with a funding deadline in mid-November. None of that threatens default in the near term, but it reinforces the sense that nobody in Washington is steering the deficit.

The taper tantrum rhyme

The closest precedent is the taper tantrum of 2013. When the Fed signalled that spring that it would slow its bond purchases, the ten-year yield rose by more than a percentage point within four months. Inflation expectations barely moved; the jump came almost entirely from the term premium and real yields, as investors adjusted to losing the largest buyer in the market. Today the Fed is doing more than stopping purchases, since it is actively shrinking its holdings, and the Treasury is borrowing far more than it did then.

Winners and losers

Borrowers carry the cost. Thirty-year mortgage rates, which price off the ten-year yield, are close to 8 per cent, the highest in more than two decades, and home sales have slumped as buyers are priced out and owners with cheap fixed-rate loans refuse to move. Companies that must refinance debt raised during the era of near-zero rates face much higher coupons. The government is the biggest loser, since each rise in yields adds to the interest bill on new issuance and makes the deficit worse.

Savers and new buyers of bonds are the winners. A real yield well above 2 per cent on ten-year inflation-linked Treasuries offers a guaranteed return above inflation that was unavailable for most of the past fifteen years. Pension funds with long-dated liabilities find it easier to match them. Stock valuations, which rest on discounting future earnings, are under pressure as the risk-free alternative becomes more attractive.

Why the move could reverse

Term premium estimates depend on models and can swing violently. A recession, a financial accident or a sharp fall in inflation would pull investors back into long bonds, as it has in every downturn of recent decades. The Treasury could also reduce long-dated issuance and lean more on bills, easing the supply pressure. Those are real possibilities, and the refunding announcement on 1 November and the Fed's meeting the same day are the next tests. Until one of them changes the arithmetic, the premium has good reasons to stay.

The ten-year yield has neared five per cent because investors have started charging properly for Washington's deficits and for the risk of holding long bonds. Nobody is panicking about inflation. Until the fiscal outlook improves, that higher charge is likely to stick, and homebuyers and refinancing companies will pay it through next year.