Interest rates for mortgages, credit cards, and business loans have surged, a development that has startled investors and complicated policymaking, despite the Federal Reserve's key rate remaining unchanged since July. The rise in interest rates has coincided with a sharp increase in the 10-year U.S. Treasury yield, which has exceeded 5% for the first time since 2007.
The Federal Reserve had initially combated inflation by raising short-term market rates, which tracked increases in the Fed’s overnight lending rate. However, longer-term rates like the 10- and 30-year Treasury yields were less impacted as they reflect the long-term economic outlook.
Despite the Federal Reserve's efforts to slow economic growth to manage inflation, the economy demonstrated resilience. Economic data consistently exceeded expectations, as shown by Citigroup’s economic surprise index. This contributed to an optimistic economic outlook and subsequent rise in long-term interest rates like the 10-year yield.
However, this robust economy means that inflation hasn't cooled as quickly as anticipated by the Federal Reserve or investors.
The term premium is believed to be rising due to factors such as a growing federal budget deficit. This rise in yields is impacting entities like companies and homebuyers, causing concern about potential financial strain. Analysts at Goldman Sachs (NYSE:GS) noted that investors are focusing on companies better prepared to weather increased borrowing costs.
The S&P 500 has lost about 9% since its peak at the end of July, coinciding with the yield increase. China sold more than $45 billion of its Treasury holdings.
As a result, the Treasury Department needs to offer higher interest rates as an incentive for lenders. The Federal Reserve's balance sheet reduction is reducing demand for Treasurys, further complicating the situation.
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