Back to the Future for Bonds?

The 10-year Treasury yield has remained in a narrow range for almost four years. Will it continue to be rangebound for the foreseeable future or is the 10-year yield finally due for a breakout? Bond yields settle where they do for a variety of reasons – Federal Reserve actions, the pace of inflation and real economic activity, investor expectations, the degree of loan demand relative to the liquid asset supply, perceived credit risks, the expected risk of a recession or other potential perilous exogeneous events, the level of government debt and debt service burdens, currency movements, and an almost endless array of other forces to numerous to list. In short, predicting bond yields is “a riddle wrapped in a mystery inside an enigma” which has nonetheless never stopped any good investment strategist from trying -- again and again!

Of all the potential forces which may play a role in setting yields, I suspect the 10-year bond yield will ultimately reflect the underlying condition of the U.S. economy – that is, its sustainable pace of real economic growth and inflation. Therefore, understanding the possibilities for where bond yields may head in the coming few years probably requires an assessment of U.S. growth possibilities.