Today’s “fair value” estimate of the US 10-year Treasury yield suggests that the current market rate is unusually high and spreads will narrow soon. Yesterday’s sharp decline in the 10-year yield (driven by upbeat inflation news for October) suggests that the process of normalization has begun.
Tuesday’s bond market rally pushed the 10-year rate down to 4.44% (Oct. 14), a two-month low (bond prices and yields move in opposite directions).
Meanwhile, CapitalSpectator.com’s fair value estimate for October (using monthly data) shows the market level has increased by 1.94 percentage points – a 40-year high. (The model is based on an average of three methods, summarized here.) The current average model estimate for the 10-year rate is 2.86% for the past month – well below the 4.80% level for October (as well as yesterday’s 4.44%).
Although modeling suggests the October spread is not unprecedented, history shows that such extreme levels do not last long. As I noted in last month’s update (which still applies today): “The market is pricing the 10-year yield at an elevated and arguably unsustainable level.”
Yesterday’s sharp decline in the 10-year rate could be the beginning of normalizing the spread. Catalysts include expectations that the Federal Reserve will raise rates this cycle.
“The market is telling you they expect the Fed to start easing soon,” says Cathy Jones, chief fixed income strategist at Charles Schwab. “I would estimate early 2024.”
“Yesterday’s positive inflation news helps strengthen the case for the Fed holding off on raising rates,” advises Preston Caldwell, senior US economist at Morningstar.
In turn, the case seems to be strengthening for expecting a smaller gap between the current 10-year yield and the average model estimate shown in the chart above.
editor’s Note: The summary bullets for this article were selected by Seeking Alpha editors.