- The 2020 bear market forced interest rates to remain low.
- The 10-year Treasury yield rose above 1% even as the US was involved in riots.
- We expect a rise in inflation in 2021 that will increase interest rates in 2021.
The US 10-year Treasury note rose above 1% as of 6th January 2021 despite riots in Washington’s US capital. The violence was fueled by the Democrats’ win in Georgia’s Senate runoff election. Interest rates have been falling considerably to control the bear market caused by an economic disruption in the wake of COVID-19. It was about time that with this decline, the bond prices would begin to peak. However, we could still see that if a bull market emerges, the interest rates will rise and, consequently, pull bond rates down.
There are mixed feelings among investors about the state of the post-Trump economy. It seems a smaller number of investors are upbeat about the situation. When many investors are unsure or pessimistic about the future, they will reduce investments in risky but high-yielding projects such as real estate. In turn, they will throw their weight behind the less-risky bond investments, such as the 10-year yields. Here, bond prices will rise, followed by the rates.
The inverse is true, whereby investors’ optimism will drive them away from the bonds and into high-risk and high-reward ventures such as real estate. This situation will drive down bond rates and lower the prices. It can be equated with the occurrence of the 2008 financial crisis that hit the real estate market. At the time, the 10-year Treasury yield jumped to record highs of 4.01% in 2010.
So, are we going to see an increase in the 10-year yield?
2021 outlook for the 10-year yield
Two stimulus checks were issued in 2020, and some analysts are grappling with the idea that a third is on the way in 2021. The Senate blocked the President’s push for the $2,000 payment, and the $600 payout stood. So yes, the incoming President Biden may decide to negotiate an additional stimulus. However, the US economy has been savagely hit by the COVID-19 pandemic.
The Fiscal Year (FY) 2020 saw government spending rise to $6.5 trillion, with a deficit of $3.1 trillion and a $2.6 trillion stimulus expenditure. Indications show that with up to $900 billion set aside as stimulus tax relief, the money supply carried forward into 2021 may be higher than imagined.
We may see an increase in the Consumer Price Index (CPI) that rose by 0.2% in November 2020. The CPI shows the inflation status in the country as it details the price changes of essential products. We know that an increase in the economy’s money supply gradually increases the rate of inflation. This pressure will force the Federal Reserve to authorize a raise in the interest rates to shrink the current money supply.
It seems investors are hoping for an increase in interest rates in 2021. With lower purchasing power expected in the market, government bond yields will increase. There will be additional purchases into the low-risk 10-year yield.
Inflation is expected to rise to 2.1% from 1.6% in 2021 as the economy gains strength post-pandemic. The recession of the pandemic will push up prices of essential commodities that had been suppressed. We are looking at the ongoing vaccination program that seeks to jumpstart the transport sector. It may be expected that interest rates may remain low, but this situation may be halted once the new administration takes office. The low-interest rates will not be permanent. The next FED meeting set for the end of January 2021 may indicate a rise in interest rates. This situation will increase the 10-year Treasury yield further above 2%.