A Deep Dive on the Recent Spike in U.S. Treasury Yields

Executive summary:

  • U.S. Treasury yields have increased noticeably since September, particularly at the long end of the curve.
  • Most of the recent jump in rates is driven by an increase in the term premium. We estimate that the higher-for-longer narrative has been the key driver, with investors forced to reconsider the possibility of not just a more gradual cutting cycle, but the risk of U.S. Federal Reserve (Fed) rate hikes in the year ahead.
  • We don’t believe the Fed will hike rates in 2025, as we don’t see strong evidence for a reacceleration in inflation.
  • We do believe the big backup in yields is starting to make bonds more attractive again.

U.S. Treasury yields have increased notably since September, particularly at the long end of the curve, with the 10-year yield up over 100 basis points from its recent lows. We unpack the drivers behind this big move in rates and our outlook for bonds going forward.

Decomposing the spike in U.S. Treasury yields

Treasury yields at any maturity can be decomposed into two factors:

  1. Expectations for Fed policy over the life of the bond plus
  2. A term premium—or risk premium—that compensates bond investors for the uncertainty around that policy outlook

We find that most of the recent jump in rates—approximately 75% of it—is driven by an increase in the term premium—the yellow section of the chart below. The remainder shows a resilient economy and uneven inflation progress, which drove the Fed to deliver a hawkish cut at its December meeting.

decomposition