Will bond yields see normal levels again soon?

With the yield on the 10-year Treasury bond hovering around a 13-month high of 2.12% following a spike this week, there is reason to think that the combination of investor psychology and economic realities will start pushing bond yields back to normal levels. “For the past two years, Treasuries have traded at lower yields than the economic fundamentals have justified because of the Fed's quantitative-easing policies and because investors have been looking for a safe haven from problems in Europe,” said Jake Lowery, portfolio manager at ING U.S. Investment Management. “At this point, the eurozone crisis has dropped in intensity, but the more immediate cause for the sell-off in Treasuries is that the markets have anticipated a more rapid tapering of the Fed's purchases of Treasuries and agency mortgages.” The current yield to maturity on the 10-year Treasury is 2.12%, which is down from the Tuesday morning spike of 2.22% but still above the 12-month range of between 1.38% and 2.05%. The yield also represents both a 50-basis-point gain over the past 30 days and a 54% increase from the July 2012 bottom of 1.38%. This is all happening while the Board of Governors of the Federal Reserve System continues its quantitative-easing policy by purchasing $85 billion worth of Treasuries and agency mortgage debt each month. In essence, the yield on the closely watched 10-year Treasury is climbing despite the Fed's best efforts to keep it low in an effort to fuel economic growth. The Fed has tremendous power, but one thing it can't do is force investors to own Treasury bonds, and as investors sell those bonds, the price drops while the yield climbs in an inverse relationship. “This [Treasury yield volatility] is all from a combination of stronger-than-expected economic data, as well as investors thinking the Fed could begin tapering back on quantitative easing,” said Jeff Margolin, senior vice president and closed-end-fund analyst at First Trust Portfolios LP. Fed Chairman Ben S. Bernanke already has stated that the QE policy will stay in place until at least next year. But that statement wasn't carved in stone, and as better economic data are reported, more of the market will try to anticipate a move by the Fed that could force bond yields higher and prices lower. “If we all knew that the Fed was going to be out of the stimulus business on a certain date, we wouldn't wait till that time to get out, so you wind up discounting the fact the Fed will be getting out of quantitative easing,” said Hugh Lamle, president of M.D. Sass Investors Services Inc. “In the first iteration, the Fed stops buying Treasury bonds, then investors start selling, then the Fed starts selling,” he said. “Nobody wants to get caught in a sudden yield spike from a rapid shift in psychology, and that psychology is already gradually at play.” Last July, when the 10-year yield dipped to 1.38%, much of the market saw it as a bottom. But now the increased volatility is suggesting more pressure to the upside, according to Wilmer Stith, co-manager of the Wilmington Broad Market Bond Fund. “The yield pushed through a new support level on Monday night, and that suggests that in the next month or so, the yield could push to the next level toward the 2.4% high from March 2012,” he said. “Pushing through a support level is pretty significant because in the past, when we've gotten to a support level, we've stopped short.” The fact that the yield hasn't come down significantly from the spike this week could mean that demand for U.S. debt from the international community is fading, Mr. Stith said. “Maybe there isn't going to be as much demand as there was a year ago when we got to 2.4%,” he said. “Back in March of this year when the yield got to over 2%, the international community thought that was an attractive level, but not this time.”