Why U.S. Interest Rates Will Rise

Paresh Upadhyaya
Senior Vice President
Director of Currency Strategy, U.S.

10-year Treasury yields have become disconnected from economic fundamentals.  We believe interest rates will gradually pull higher due to the strengthening U.S. economy, making duration risk in bond portfolios a serious concern for investors, but not to the extent of the Great Bond Bear Market of 1994.

Key Points

  • Central banks have taken numerous measures to inject liquidity into their domestic economies. That has helped boost risk appetite and investor sentiment.
  • Investors are growing concerned that yields, which move inversely to prices, have bottomed for the 10-year Treasury and could surge, raising fears of a bond bear market along thelines of the Great Bond Bear Market of 1994.
  • With debt-to-GDP skyrocketing from 36.3% in 2008 to 74.2% in March 2013, and10-year yields near recent lows, there appears to be little debt risk premia priced into the Treasury market.
  • Quantitatively, the 10-year’s yield is out of sync with current fundamentals. Presently, both real GDP and inflation are growing around 2% in the U.S., which would equate to 10-year yields intuitively yielding around 4% more than double current levels.
  • If the economy continues to maintain its current recovery, and perhaps gain some momentum with unemployment maintaining its gradual descent, and inflationexpectations remain near 2%, we think 10-year yields can be expected to rise gradually over the next few years.
  • Bond investors may face meaningful duration risk in their portfolios but not to the extent of 1994 and the Great Bond Bear Market.

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