Treasury yields are once again surging buoyed by rounds of upbeat economic data and hawkish comments from Federal Reserve policymakers. Notably, the 10-year Treasury yields hit its highest level since July 2011 at 3.162% while the 30-year yield touched 3.318% – its highest level since October 2014.
Private-sector employment jumped with 230,000 job additions in September – the largest gain since February, per a report from Automatic Data Processing. Another report from the Institute for Supply Management showed that the U.S. services sector expanded at its fastest pace on record in September. The ISM non-manufacturing index rose to 61.6 last month, the highest level since the index was created in 2008.
The Fed is on track for gradual rate hikes this year, citing that the economy is strong and can handle a tighter monetary policy. Federal Reserve Chairman Jerome Powell said the central bank is “a long way” from getting rates to neutral, a fresh sign that he believes more hikes are coming. He further added that the ultra-accommodative policy to bring the economy out of the Great Recession is no longer needed. The central bank, which began to tighten monetary policy in 2015, has raised rates thrice this year and is expected to do so again in December.
The combination of all these factors boosted investors’ confidence in the American economy, leading to a spike in yields.
Pros and Cons
A rising rate environment is highly beneficial for cyclical sectors like financial, technology, industrials, and consumer discretionary. Banks are at the most advantageous position as they seek to borrow money at short-term rates and lend at long-term rates. If interest rates rise, banks would be able to earn more on lending and pay less on deposits. This will expand net margins and boost banks’ profits. Also, insurance companies are able to earn higher returns on their investment portfolio of longer-duration bonds.
Higher rates attract more capital to the country from foreign investors, thereby boosting the U.S. dollar against the basket of other currencies. However, this will have a huge impact on commodity-linked investments, reflecting that a rising rate environment will hurt a number of segments. In particular, high dividend paying sectors such as utilities and real estate will be the worst hit, given their higher sensitivity to rising interest rates. Additionally, securities in capital-intensive sectors like telecom will also be impacted by higher rates.