To predict the economy’s direction, ignore the Fed and monitor this specific interest rate. Anything over 4% is negative.

To predict the economy's direction, ignore the Fed and monitor this specific interest rate. Anything over 4% is negative.

The Impact of the 10-Year Treasury Yield on Borrowing Costs, Mortgage Rates, and Stock Prices

Our team of experts is here to provide valuable insights and answer your burning investing questions. In this article, we will delve into the relationship between the Federal Reserve’s interest rate hikes, the 10-year US Treasury bond yield, borrowing costs, mortgage rates, and stock prices.

The Federal Reserve’s Interest Rate Hikes and Borrowing Costs

Contrary to popular belief, it’s not the Federal Reserve’s interest rate hikes that directly influence borrowing costs for most people. Instead, it is the closely monitored yield on the 10-year Treasury bond that holds the key. This long-term rate controls the cost of money for consumers and impacts various important economic factors.

The 10-year Treasury yield often responds to the Federal Reserve’s rate hikes in two different ways. In some instances, when the Fed raises rates, investors interpret it as a positive signal for the economy and expect lower future inflation. As a result, the yield on the 10-year Treasury bond declines, leading to a decrease in borrowing costs in the real world.

However, there are also times when the market perceives the Fed as being behind the curve, causing anxiety about excessive economic growth and higher future prices. In these situations, the 10-year Treasury rate climbs, and real-world borrowing costs increase.

It is crucial to closely monitor the 10-year Treasury yield as a reliable indicator of our economic future. Generally, the higher the yield, the worse things are expected to become.

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The Link Between the 10-Year Treasury Yield and Mortgage Rates

The relationship between the 10-year Treasury yield and mortgage rates is particularly significant. For mortgage lenders, the yield indirectly influences the cost of offering 30-year fixed-rate mortgages.

When a mortgage lender provides a 30-year fixed-rate mortgage at, for example, 5% annually, they often sell these mortgages as assets to investors. If the 10-year Treasury bond pays 4%, investors may prefer the safer option of buying the Treasury bond instead of the mortgage bond, which carries additional risk. Consequently, lenders must charge higher interest rates, around 7%, to compensate for this risk. As a result, the cost of purchasing a house increases, potentially leading to a decline in house prices, fewer housing constructions, and a slower economy.

Currently, 30-year fixed mortgage rates are averaging about 7.3%. If the 10-year Treasury bond yield, which recently surpassed 4.1%, continues to remain high, mortgage costs are likely to rise and reach new 20-year highs.

This relationship between the 10-year Treasury yield and borrowing costs applies not only to mortgages but to other types of loans as well, such as auto loans, business acquisition loans, and financing for construction projects.

Source: FRED, Federal Reserve Bank of St. Louis

The Impact on Stock Prices

Not only does the 10-year Treasury bond yield affect borrowing costs, but it also has a substantial impact on the stock market, particularly for technology companies.

Investors value stocks based on future earnings rather than immediate profits, a principle that holds true for rapidly growing technology companies that may not generate significant profits for years. To determine the present value of future earnings and accurately assess a company’s current valuation, investors discount those earnings.

The 10-year Treasury bond yield serves as a commonly employed discounting factor. Let’s consider an example: if the 10-year yield is 2%, the present value of future profits worth $10 billion in ten years would be slightly lower. However, if the 10-year Treasury yield increases to 4%, the current value of those $10 billion in future profits diminishes significantly.

Consequently, when the 10-year Treasury bond yield surges, it often leads to a decline in tech stocks. This phenomenon was evident when the Nasdaq experienced a 2.2% drop, marking its worst day since February.

Understanding the relationship between the 10-year Treasury yield and various financial aspects can be immensely beneficial for investors and individuals seeking mortgages or other loans. Monitoring the 10-year Treasury yield is a valuable tool in predicting economic trends, anticipating shifts in borrowing costs, and evaluating stock market movements.

Note: The views and opinions expressed in this article are solely those of the author and do not constitute investment advice. Please consult with a qualified financial advisor before making any investment decisions.

• Economy
• Federal Reserve
• finance