Treasury yields are higher, but not unanchored

Higher Treasury yields are broadly justified by nominal growth and fiscal deterioration, but an energy-led inflation shock and a softer labor market argue against an extended hiking cycle, leaving the 10-year yield near the upper end of fair value.

• US nominal GDP growth is 6.6% year over year, up from 4.6% a year ago, while the 10-year Treasury yield remains about 160 basis points below it; using the post-2000 relationship, a yield near 5.7% could still be consistent with fundamentals.
• The US deficit is projected at USD 1.9 trillion this year, federal debt exceeded USD 40 trillion in August, and net interest outlays reached USD 857 billion in the first nine months of the fiscal year, up 13% year over year.
• Debt held by the public is projected to rise from 101% of GDP in 2026 to 120% in 2036; applying the authors' estimated 2-to-4-basis-point yield effect per percentage point of debt implies 40 to 75 basis points of additional term premium over the decade.
• Headline CPI is 3.4%, with energy contributing one percentage point, but core CPI is 2.4%, wage growth has slowed to 3.1% from 5.9% in the first quarter of 2022, and core services inflation shows no renewed upward pressure.
• Real GDP growth is forecast at 1.7% in the third quarter and 2.1% in the fourth, supported by AI-related investment, while the 12-month payroll average is only about 50,000 jobs per month despite August payroll growth of 162,000.

Takeaway: The authors estimate fair value for the 10-year Treasury at 4.7%–5.2%, have moved from underweight to neutral after the yield rose from 4.4% at end-June to 5.2%, favor duration at the short end, and would reassess if services inflation or wage growth reaccelerates.