The Ten Year Treasury Touched Five Percent and Then Reversed Hard
On October 23 the benchmark yield reached 5.02 percent, a level not seen since before the financial crisis. It ended the year near 3.8 percent, and the round trip is a lesson in term premium.
The Level
The ten year Treasury yield reached 5.02 percent on October 23, 2023, the highest since 2007. By the end of December it had fallen to roughly 3.8 percent. A move of more than a percentage point in the benchmark rate within two months is enormous, and it happened without a recession, a crisis, or a change in the policy rate.
Decomposing a Long Yield
A ten year yield contains two components. The first is the average short term rate investors expect over the next decade. The second is the term premium, meaning the extra compensation demanded for bearing the risk of holding a long bond rather than rolling short ones.
Through the autumn of 2023, the increase came substantially from the term premium rather than from higher expected policy rates. Investors were demanding more compensation to hold duration, and the reasons had less to do with inflation than with supply and uncertainty.
A rising long yield does not automatically mean higher expected inflation. It can mean investors want to be paid more for the same risk, which is a different message entirely.
The Supply Story
Federal deficits were large and Treasury issuance was heavy. At the same time, two of the largest historical buyers had stepped back. The Federal Reserve was reducing its holdings through quantitative tightening rather than reinvesting. And foreign official demand had softened.
When supply increases and the least price sensitive buyers withdraw, the remaining buyers are private investors who care about price. They will absorb the paper, at a yield that compensates them. That is a mechanical repricing rather than a macroeconomic forecast.
The Reversal
The turn came quickly. Treasury adjusted the composition of its issuance toward shorter maturities, reducing pressure on the long end. Inflation data continued improving. And in December the Federal Reserve signaled that rate cuts were plausible in the following year.
Markets moved rapidly to price multiple cuts, and long yields fell hard. Notably, the market priced considerably more easing than the Fed had actually signaled, which is a recurring pattern worth remembering. Markets do not price the central bank's stated path, they price their own expectation of it.
What Five Percent Meant for Everyone Else
The level matters beyond the bond market. The thirty year mortgage rate is priced off the ten year plus a spread, and it approached 8 percent during this period, the highest in decades.
Equity valuation is affected too. The risk free rate is the base of the discount rate, so a higher ten year mechanically lowers the present value of distant cash flows. Long duration growth stocks, whose value sits far in the future, are most sensitive. That is why the autumn selloff hit growth hardest and why the December rally reversed it in the same names.
The Bottom Line
The ten year touched five percent on term premium and supply rather than on inflation fear, then round tripped when the Fed blinked. Decomposing a yield into expectations and premium is what separates reading the bond market from watching it.