As the 10-year US Treasury yield moves closer and closer to 3% — a token level not seen since late 2018 — financial analysts have described how it could affect people’s finances in multiple ways.
Last week, the 10-year rate hit 2.94%, its highest level in more than three years. It’s also a big jump from where the 10-year started the year, at around 1.6%. This is important because it is considered the benchmark for rates for all kinds of mortgages and loans.
Soaring inflation, exacerbated by the Russian-Ukrainian war, has raised concerns that it could hurt consumer demand and dampen economic growth. In addition, there are fears that the Federal Reserve’s plan to rein in rapidly rising prices by aggressively raising its key rate and generally tightening monetary policy could also tip the economy into a recession.
As a result, investors sell bonds, pushing yields higher because they have an inverse relationship. So what would it mean for your money if this rate reached 3%?
Loans and mortgages
One consequence of rising yields is higher borrowing costs on debt, such as consumer loans and mortgages.
For example, Schroders investment strategist Whitney Sweeney told CNBC via email that the effect of a higher 10-year yield on college loans will be felt by students who take out federal college loans. upcoming school year.
“The rate is set by Congress approving a margin applied to the May 10 Treasury auction,” she said, but pointed out that the rate is currently zero for existing federal student loans due to the measures. pandemic relief.
In addition, Sweeney said variable-rate private student loans are expected to rise as the 10-year Treasury yield climbs.
Sweeney said mortgage rates tend to move with the 10-year Treasury yield. “We have already seen a significant rise in mortgage rates since the start of the year,” Sweeney added.
Meanwhile, Antoine Bouvet, ING’s senior rates strategist, told CNBC via email that higher interest rates on government debt would also mean higher returns on savings invested in fixed income securities. fixed income.
“It also means that pension funds have less difficulty investing to pay future pensions,” he added.
In terms of stock market investments, however, Bouvet said higher bond interest rates would likely make the environment more difficult for sectors whose companies tend to take on more debt. This is something that has been associated with tech companies and part of the reason this sector has seen greater volatility recently.
Similarly, Sweeney pointed out that when returns were closer to zero, investors had no choice but to invest in riskier assets such as stocks to generate returns.
But as the 10-year Treasury yield nears 3%, she told CNBC via email that cash and bonds are becoming “more attractive alternatives because you get paid more without taking as much risk.”
Sweeney said shorter-dated bonds, in particular, may look more attractive, given that’s where significant interest rate hikes have already priced in.
Wells Fargo senior macro strategist Zach Griffiths told CNBC in a phone call that it’s also important to understand what higher yields will mean for companies’ future cash flows, when it comes to is about investing in stocks.
He said one way to value stocks is to project the level of free cash flow the company is expected to generate. This is done by using a discount rate, which is a type of interest rate, informed by Treasury yields. Discounting cash flows to the current level represents intrinsic value to a business.
“When the rate used to discount those future cash flows to the present is low, then the present value of those cash flows (i.e. the intrinsic value of the business) is higher than when the rates are high because of the time value of money,” Griffiths explained via email.
Still, Griffiths said equities have broadly managed to weather the uncertainty presented by higher inflation, geopolitical tensions and a more hawkish tone on Fed policy.
Griffiths also pointed out that a 3% yield on the 10-year Treasury yield was really a “psychological level,” given that it wouldn’t represent much of an increase from the current rate. He said Wells Fargo expected the 10-year yield to end the year above 3% and did not rule out it reaching 3.5% or 3.75%, but said pointed out that this was not the company’s “baseline scenario”.
To verify: How to protect your savings as inflation soars