As the yield on the 10-year US Treasury bond gets ever closer to 3% — a symbolic level not seen since late 2018 — financial analysts have described how this could affect people’s finances in a variety of ways.
Last week, the 10-year rate hit 2.94%, its highest level in more than three years. That’s also a big jump from where 10-year-olds started the year at around 1.6%. It matters because it serves as a benchmark for interest rates on all types of mortgages and loans.
Soaring inflation, exacerbated by the war between Russia and Ukraine, has raised concerns it could hurt consumer demand and hamper economic growth. In addition, there are fears that the US Federal Reserve’s plan to stem rapidly rising prices by aggressively raising interest rates and generally tightening monetary policy could also plunge the economy into recession.
As a result, investors have sold bonds, which pushes yields higher as they have an inverse relationship. So what would it mean for your money if that rate reached 3%?
loans and mortgages
One consequence of rising yields is higher borrowing costs for debt such as consumer loans and mortgages.
For example, Whitney Sweeney, Schroders’ investment strategist, emailed CNBC that the impact of higher 10-year yields on college loans will be felt by students taking out federal loans for the upcoming school year.
“The interest rate is set by Congress, which authorizes a margin that applies to the May 10-year Treasury auction,” she said, but stressed that the interest rate on existing federal student loans is currently at zero due to pandemic relief efforts .
Additionally, Sweeney said private adjustable-rate student loans are likely to rise as the 10-year Treasury yield rises.
Sweeney said mortgage rates tend to move in line with the 10-year Treasury yield. “We’ve already seen a significant increase in mortgage rates since the beginning of the year,” Sweeney added.
Meanwhile, ING senior rates strategist Antoine Bouvet told CNBC via email that higher interest rates on government bonds would also mean higher returns on savings in fixed income.
“It also means pension funds have less difficulty making investments to pay future pensions,” he added.
Speaking about stock market investing, however, Bouvet said higher bond yields would likely make it a tougher environment for sectors with companies that tend to hold more debt. This is associated with technology companies and is one of the reasons this sector has seen more volatility lately.
Similarly, Sweeney pointed out that when yields were closer to zero, investors had little choice but to invest in riskier assets like stocks to seek returns.
But as the 10-year Treasury yield approaches 3%, she told CNBC via email that both cash and bonds “are becoming more attractive alternatives because you’re getting paid more without taking on as much risk.”
Sweeney said short-dated bonds in particular may look more attractive as they are already priced in for significant rate hikes.
Zach Griffiths, Wells Fargo’s senior macro strategist, told CNBC in a phone call that it’s also important to understand what higher returns would mean for companies’ future cash flows when investing in stocks.
He said that one way to value stocks is to project into the future the level of free cash flow the company is expected to generate. It does this by using a discount rate, which is a type of interest rate that tracks government bond yields. Discounting to current cash flow levels gives an intrinsic value to a company.
“If the interest rate used to discount those future cash flows to the present is low, then the present value of those cash flows (i.e., the intrinsic value of the business) will be higher than if interest rates are high because of the time value of money.” Griffiths explained via email.
Still, Griffiths said stocks have broadly managed to weather the uncertainty brought on by higher inflation, geopolitical tensions and a more hawkish tone in Fed policy.
Griffiths also stressed that a 3% yield on the 10-year Treasury yield was very much a “psychological level” because it wouldn’t represent a huge increase over the current interest rate. He said Wells Fargo expects the 10-year yield to end the year above 3% and didn’t rule out it hitting 3.5% or 3.75%, but stressed that’s not the “base case.” of the company.