Interest Rates Tick Higher - January 25, 2021

Interest rates are very low for safe, interest-bearing investments, and savers have found the environment to be challenging. Let’s review Figure 1. Two things stand out.

First, yields have been in a long-term downward trend. Second, rates have inched up from the bottom. Still, the 10-year Treasury does not sport an attractive yield.

Longer-term yields have inched higher, but short-term rates have barely moved—see Figure 2.

Figure 2 plots Treasury yields from one month in maturity through 30 years. The illustration includes two time periods: April 1, 2020, when the national lockdown sent economic activity into a tailspin, and January 21, 2021.

The Federal Reserve said it expects to hold the fed funds rate at near zero for a considerable period. Because the Fed has control over short-term rates, yields remain near zero.

While the Fed’s stance will influence longer-term yields, other factors also play a role. So, why have long-term yields inched off the bottom?

In part, the economy is expected to continue to expand through 2021, though the pace will probably be uneven. An expanding or accelerating economy can help put a floor or put upward pressure on yields.

Next, there is talk of additional fiscal stimulus. Although more spending will probably provide an economic boost, it could also lift inflation, which might affect yields.

Think of it this way. If investors expect inflation to speed up, they are likely to demand a higher yield for a longer-term bond. If not, they could get stuck in low-yielding debt that cannot keep pace with inflation.

Today, the rise in yields is likely due to investors trying to price in an expanding/accelerating economy and the potential for an uptick in inflation.

Nonetheless, at just above 1%, the 10-year Treasury remains low, and the rise in yields has yet to offer much competition for stocks amid an economy that is expected to grow this year.