Is the 10-Year Treasury Rate Set to Fall as Inflation Eases?
James Picerno | Apr 14, 2023 13:58
The 10-year Treasury rate continues to trade well above CapitalSpectator.com’s fair-value estimate, but the days of a large premium look numbered. As evidence mounts that inflation continues to ease, money supply remains sharply negative on a rolling one-year basis and the economy faces stronger headwinds, the odds are rising that the yawning gap between the current 10-year yield and our fair-value estimate will narrow.
The question is whether the fair-value estimate will rise, the 10-year rate will fall, or a bit of both. The market has already trimmed the 10-year rate slightly since last month’s update. In yesterday’s trading, the benchmark yield was 3.45% (as of Apr. 13), or nearly 20 basis points lower since the March 15 update, when I wrote:
“My view is that most of the spread narrowing will be borne by a lower market yield. This is based on the assumption that inflation will continue to ease and economic growth will remain relatively subdued at best.”
Those conditions remain in play as the second quarter begins. As reported yesterday, the US consumer inflation trend continued easing in March. Nonetheless, the Federal Reserve is still expected to raise its benchmark rate by ¼-point again at the next FOMC meeting on May 3. But as shown by today’s update of fair-value modeling for the 10-year yield, the numbers continue to suggest that the benchmark rate has peaked.
The fair value for the 10-year rate slipped to 2.76% for March, down fractionally from the previous month’s estimate. The fair value is based on the average of three models, defined here.
The market yield is still nearly 1 percentage point higher, which suggests that investors continue to overvalue this Treasury Note by a relatively wide margin. Moderate degrees of overvaluing and undervaluing are normal, of course, in part because no model fully captures all the factors that determine bond prices in real time. Nonetheless, the extent of overvaluation lately has been extreme, as shown in the chart below – a condition that adds to the expectation that the 10-year yield has peaked for the near term and will probably edge lower.
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What would change the calculus in favor of a flat or higher 10-year rate? A revival in inflation’s pace is the leading candidate, along with firmer-than-expected economic growth. But on both fronts the numbers are expected to skew lower for the near term. In turn, the relatively high premium for the 10-year rate looks set to narrow in the months ahead.
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