Creditors of the world’s most closely watched bond – the 10-year US Treasury note – face the prospect of bearing a historic precedent: losing money on their investment for the third year in a row.
- The 10-year US Treasury note, which was issued almost a century ago, has never depreciated for three years in a row.
- After slumping in 2021 and posting its worst ever loss last year, it is down 1.2% so far this year.
- Investors can now get 10-year returns that comfortably exceed annual inflation, which can boost demand for the world’s leading bonds – and help them avoid making history.
The 10-year note has lost 1.2% this year, after posting its worst ever loss, 17.8%, in 2022 and falling 4.4% in the previous year. year.
There has never been three consecutive years of annual declines in 10-year notes, according to available data going back nearly a century. Furthermore, since 1928, 10-year securities have lost money in just 19 calendar years — which means they’ve generated a positive annual return 80% of the time.
Fallout from the Fed battle
Bond prices fall as yields rise, and the Fed’s drive to lower inflation has pushed the 10-year yield near 4.30%. This is eight and a half times higher than it was just three years ago, during the height of the pandemic lockdowns, and the highest trading range since 2007. Historically low yields reflect the high demand for 10-year bonds from fearful investors looking for a safe haven for their assets. It earned 11.3% in 2020, its highest annual return since 2011.
But it has accumulated losses since then, the bulk of which comes after the Fed began steadily raising its benchmark lending rate a year and a half ago to combat the worst US inflation in four decades.
The complexities of the American budget
Despite the disappointment for investors, the struggle faced by 10-year securities presents somewhat of a dilemma for the US government, which relies on investments in them as a major source of funding for its operations.
The market value of outstanding government debt reached an all-time high of $25.1 trillion at the end of July. 55% of this amount is treasury bonds with maturities ranging from 2 to 10 years.
Each subsequent Fed rate hike has reduced the value of previously issued bonds, and investors avoid buying bonds when they see the potential for higher returns in the future.
Meanwhile, the US Treasury has been forced to boost the interest rates it offers on 10-year notes through its routine auctions to attract more investment bidders. Although that increases borrowing costs, the Treasury has little choice: It needs money to plug the $1.6tn budget deficit it has accumulated so far in fiscal 2023.
Will high yield cure high yield?
Investors sold off Treasuries at a rapid pace in recent weeks after Fitch Ratings downgraded the US debt rating to AA+ from its highest rating of AAA. Standard & Poor’s Global also downgraded the US debt during a debt ceiling standoff in 2011.
As of early Friday, the yield on 10-year notes had risen about 50 basis points since mid-June, even as the Fed paused its campaign to raise interest rates.
But this increase may attract more investors. This is because they are able to secure long-term returns for the next decade that now comfortably exceed annual US inflation, which hit 3.2% in July.
Such demand, if materialized, would put downward pressure on yields. This, in turn, may help the 10-year note avoid making a rather dubious date.