10-Year Treasury Yield Tops 4% for First Time Since November

Rising yields lift borrowing costs for consumers and companies, and hurt the prices of other investments by offering steady payouts with lower risk. The climb in yields has buffeted major stock indexes, with the S&P 500 losing around 2.6% in February.

Bets that inflation would rapidly decline had stalled a yearlong bond rout in November and powered a rebound in stocks. But price pressures have lingered, pushing the Fed toward holding rates higher for longer than traders had expected.

“We’re left with a world where we need to accept that money is going to need to cost more,” said

Tim Horan,

chief investment officer for fixed income at Chilton Trust. “We’re still testing what the high is going to be for the 10-year yield this cycle.”

A Treasury bond’s yield closely follows investors’ expectations for how the Fed will set rates through the date when the bond matures. Last year’s rapid increases drove the largest calendar-year yield rise for the 10-year on record in data going back to the late 1970s. Stocks suffered their worst year since 2008. 

Investors spent much of 2022 wondering how high rates would eventually rise, and how quickly. In recent months, some of that uncertainty seemed to resolve as expectations crystalized around an eventual Fed rate target of roughly 5%, with some investors betting that a policy reversal—rate cuts—could follow later in 2023.

Now, that outlook is facing new tests. The Fed’s rate target, now at 4.5% to 4.75%, is approaching the 5% level that officials thought as recently as December would be high enough to control inflation. But the latest economic data have indicated that isn’t happening yet.

Early in February, Labor Department data showed that unemployment fell further to start 2023, potentially extending upward pressure on wages.

Then, last week, the latest release of the Fed’s preferred inflation gauge, the personal-consumption expenditures price index, showed that price increases accelerated again in January.

Goldman Sachs

economists wrote Monday that they no longer believe PCE inflation will fall below 3% this year.

“The employment picture and the wage picture have been a lot stronger and a lot stickier than people thought,” said

Ben Santonelli,

a portfolio manager at Polen Capital Credit. 

In addition to denting stock prices, the recent climb in yields has begun spilling over into other debt markets, such as the junk-bond market where Mr. Santonelli invests. That has lifted the yield offered by bonds rated below investment-grade. It also raises those companies’ borrowing expenses, and, at the margins, threatens to undermine business conditions for weaker firms, he said.

Even as the 10-year yield climbed in February, the two-year Treasury yield, which is especially sensitive to Fed rate expectations, raced higher even faster. It traded Wednesday at a recent 4.885%, compared with 4.795% on Tuesday afternoon.

A situation in which short-term Treasurys offer higher yields than longer-term bonds is known on Wall Street as an inverted yield curve. Longer-term Treasurys typically yield more than shorter-term notes to compensate investors for the risk of future unexpected bouts of inflation and interest-rate increases. Inversions often signal to investors that a recession is on the way, because they imply an expectation that the Fed will need to cut rates in the near future to cushion a slowing economy. 

At a premium of nearly 0.9 percentage point, the two-year Treasury note hasn’t yielded so much more than the 10-year note since October 1981, according to Dow Jones Market Data.

Behind the inversion lie mounting bets that with strong economic data rolling in, rate cuts are growing less likely in the near future. A month ago, derivatives traders were highly confident that the Fed’s target rate would finish 2023 below 5%, but now, futures markets are broadcasting 9-in-10 odds that rates will be above 5% at the end of December.

Nonetheless, some investors who believe that high interest rates will prove temporary have added to their holdings of Treasurys.

Mohit Mittal,

a managing director at Pacific Investment Management Co., said that the portfolios he manages have taken the recent fall in Treasurys prices as an opportunity to buy more longer-term government debt.

Market-based forecasts show that investors are still expecting the 12-month inflation rate to fall to close to 3% this year, from 6.4% in January. If it does, that would make real yields—the yields on government debt, adjusted for inflation—unsustainably high, Mr. Mittal said.

“It’s unlikely that an economy as levered as the U.S. economy can take real yields like that for an extended time,” he said. “At some point, the expectation is that the Fed will have to cut.” 

Write to Matt Grossman at matt.grossman@wsj.com

Rising yields lift borrowing costs for consumers and companies, and hurt the prices of other investments by offering steady payouts with lower risk. The climb in yields has buffeted major stock indexes, with the S&P 500 losing around 2.6% in February.

Bets that inflation would rapidly decline had stalled a yearlong bond rout in November and powered a rebound in stocks. But price pressures have lingered, pushing the Fed toward holding rates higher for longer than traders had expected.

“We’re left with a world where we need to accept that money is going to need to cost more,” said

Tim Horan,

chief investment officer for fixed income at Chilton Trust. “We’re still testing what the high is going to be for the 10-year yield this cycle.”

A Treasury bond’s yield closely follows investors’ expectations for how the Fed will set rates through the date when the bond matures. Last year’s rapid increases drove the largest calendar-year yield rise for the 10-year on record in data going back to the late 1970s. Stocks suffered their worst year since 2008. 

Investors spent much of 2022 wondering how high rates would eventually rise, and how quickly. In recent months, some of that uncertainty seemed to resolve as expectations crystalized around an eventual Fed rate target of roughly 5%, with some investors betting that a policy reversal—rate cuts—could follow later in 2023.

Now, that outlook is facing new tests. The Fed’s rate target, now at 4.5% to 4.75%, is approaching the 5% level that officials thought as recently as December would be high enough to control inflation. But the latest economic data have indicated that isn’t happening yet.

Early in February, Labor Department data showed that unemployment fell further to start 2023, potentially extending upward pressure on wages.

Then, last week, the latest release of the Fed’s preferred inflation gauge, the personal-consumption expenditures price index, showed that price increases accelerated again in January.

Goldman Sachs

economists wrote Monday that they no longer believe PCE inflation will fall below 3% this year.

“The employment picture and the wage picture have been a lot stronger and a lot stickier than people thought,” said

Ben Santonelli,

a portfolio manager at Polen Capital Credit. 

In addition to denting stock prices, the recent climb in yields has begun spilling over into other debt markets, such as the junk-bond market where Mr. Santonelli invests. That has lifted the yield offered by bonds rated below investment-grade. It also raises those companies’ borrowing expenses, and, at the margins, threatens to undermine business conditions for weaker firms, he said.

Even as the 10-year yield climbed in February, the two-year Treasury yield, which is especially sensitive to Fed rate expectations, raced higher even faster. It traded Wednesday at a recent 4.885%, compared with 4.795% on Tuesday afternoon.

A situation in which short-term Treasurys offer higher yields than longer-term bonds is known on Wall Street as an inverted yield curve. Longer-term Treasurys typically yield more than shorter-term notes to compensate investors for the risk of future unexpected bouts of inflation and interest-rate increases. Inversions often signal to investors that a recession is on the way, because they imply an expectation that the Fed will need to cut rates in the near future to cushion a slowing economy. 

At a premium of nearly 0.9 percentage point, the two-year Treasury note hasn’t yielded so much more than the 10-year note since October 1981, according to Dow Jones Market Data.

Behind the inversion lie mounting bets that with strong economic data rolling in, rate cuts are growing less likely in the near future. A month ago, derivatives traders were highly confident that the Fed’s target rate would finish 2023 below 5%, but now, futures markets are broadcasting 9-in-10 odds that rates will be above 5% at the end of December.

Nonetheless, some investors who believe that high interest rates will prove temporary have added to their holdings of Treasurys.

Mohit Mittal,

a managing director at Pacific Investment Management Co., said that the portfolios he manages have taken the recent fall in Treasurys prices as an opportunity to buy more longer-term government debt.

Market-based forecasts show that investors are still expecting the 12-month inflation rate to fall to close to 3% this year, from 6.4% in January. If it does, that would make real yields—the yields on government debt, adjusted for inflation—unsustainably high, Mr. Mittal said.

“It’s unlikely that an economy as levered as the U.S. economy can take real yields like that for an extended time,” he said. “At some point, the expectation is that the Fed will have to cut.” 

Write to Matt Grossman at matt.grossman@wsj.com