July 1, 2025
The 10-year U.S. Treasury yield has always been a key rate for bankers, consumers and the real estate market. The rate has been brought more into the public domain as the Secretary of the Treasury Scott Bessent and President Trump publicly stated that they want the 10-year Treasury rate lower and are closely following that part of the yield curve.
So where is the relevant value for the 10-year Treasury? The value or composition of the 10-year treasury can be divided into the real yield and the inflation premium. The real rate is what the investor earns after taking account of inflation.
Example:
10 year nominal treasury yield 4.46%
10 year inflation rate (CPI) 2.50%
Real interest rate 1.96%
We like to look at this composition in a more forward looking way by using Treasury Inflation Protected Securities (TIPS). These securities are issued and calculated using a real yield. This allows us to look at the difference between the nominal yield (4.46%) and the same maturity TIPS real yield (2.15%) as the breakeven inflation rate, commonly known as inflation expectations, for 10 years. When we look at inflation expectations, they have been between 2.10% and 2.50% for the last three years. Inflation expectations have been well contained based on market inflation interpretations.
What has been primarily driving the move in nominal yields the last few years has been real rates. The recent rise in real rates is the market putting in a yield cushion for the risk that 1) inflation moves higher due to the tariff program, 2) expectation that the supply of treasuries increases, 3) increasing federal deficits.
Since the Federal Reserve increased interest rates in 2022, peaking at 5.25%-5.50% and then reducing them 100 basis points to the current level of 4.25% to 4.50%, the 10-year note went from 3.82% (end of 2022) to the current level of 4.46%. A rise of 64 basis points. During that same period, 10 year inflation expectations are at the same level of 2.28%. However, the 10-year real yield went from 1.53% to 2.10%. 92% of the rise in 10-year rates has been driven by real yields. If we believe inflation expectations will remain manageable, future moves in 10-year rates will be primarily driven by real yields.
So, does a 4.46% 10-year note have value? Should it be at 5% due to rising debt levels and increasing deficits? Should it be at 4% with inflation being manageable, GDP growth potentially slowing allowing the Federal Reserve to lower the Federal Funds Rate to 4% or lower?
The 10-year maturity is more influenced by inflation, inflation expectations and to some extent supply. The change in the Federal Funds rate affects shorter maturities the most and yet can influence the 10-year by the shape of the yield curve. If the Federal Funds rate is lowered, the shorter maturities move lower in yield while the 10-year note does not fall as fast, so the difference in yields widens, or in market speak, the yield curve steepens. The opposite happens when short rates go higher. The yield curve shrinks or flattens. When the Fed lowered interest rates to 0% during the Covid pandemic, the yield differential (spread) between 2-year and 10-year treasuries went to +150 basis points. When the Fed started raising interest rates in 2022, this spread went to –100 basis points. Recently with the Fed lowering interest rates by 100 basis points, the spread is now 50 basis points. The Fed has indicated it may lower rates another 50 basis points (two 25 basis points cuts) this year. In this case the curve may steepen out further a bit to 70-75 basis points which would put the 10 year around a 4.20-4.25%.
Currently the yield on the 10-year treasury and the Federal Funds rate are nearly the same. From 2010 to 2022 (Fed Funds rate ranged from 0% to 3.5%) the average yield was 140 basis points higher than the Federal Funds rate. From 2022 to today (Federal Funds rate ranged from 3% to 5.50%), the yield averaged –95 basis points. With the current spread of almost zero, I would say the yield currently on the 10-year treasury is fair.
When valuing the 10-year treasury versus inflation, I look for value and compare the rate to core Personal Consumption Expenditure, core PCE (the Fed’s preference) and core Consumer Price Index, core CPI. Core PCE peaked at 5.60% in 2022 and is now at 2.52% as of April. Currently the 10-year is 195 basis points higher than core PCE, the widest or cheapest in the last 12 years. When looking at the 10-year vs core CPI, it is 162 basis points higher which is the cheapest since 2011. The 20-year average is 93 basis points so I will conclude that the 10-year treasury is of fair value and on the cheaper side of inflation. Bond volatility seems very calm with 10-year rates between 4.25% and 4.5% indicating yield levels aren’t too threatening.
There is value in 10-years above 4.50% and it is fair value around 4.25%. Since October of 2024, the 10-year yield has been between 4.15% and 4.60% most of the time. A 3.5 point price range. In that time period we elected a new president, a slew of tariffs was enacted, supply has crept up, deficits are higher, the U.S. was downgraded to AA1 by Moody's, geopolitical issues are increasing, and the dollar is down 9% year to date. A lot has been thrown at the bond market, yet the yield is 40 basis points lower than the 4.80% peak in January.
This is an excellent time to have fixed income exposure to earn the income and be an anchor to an equity strategy. This can be achieved either through a bond ladder approach or through an intermediate total return strategy.