Treasury Yields May Keep Rising And That Is Worrisome

You’ve managed to stay afloat through property challenges, avoided an immediate refinance, and waited things out. Then, the Federal Reserve made its third interest rate cut this fall, bringing hope that a little more relief might be on the way.

But recently, the Fed has signaled it will likely slow the pace and timing of rate cuts in 2025. This is unwelcome news for those seeking bridge or construction loans.

What does this mean for commercial real estate (CRE) mortgages? If T. Rowe Price Chief Investment Officer of Fixed-Income Arif Husain’s outlook holds, there may be more bad news ahead. In a recent report, Husain pointed out that U.S. fiscal expansion and potential tax cuts, coupled with a strong economy, are likely to push Treasury yields higher. He predicted that the 10-year yield could hit 5% by the first quarter of 2025, with the possibility of rising to 6%. This past Wednesday, the 10-year yield climbed to 4.5%, a level not seen since May 2024.

Rising 10-year yields signal greater risk-free long-term returns, which will likely lead lenders to increase CRE mortgage rates.

Husain identified six factors contributing to higher rates, but overall, he believes four of them will outweigh the other two.

The first four factors supporting higher rates are:

1. U.S. fiscal expansion: With a budget equaling 7% of GDP and the Trump administration pushing for tax cuts, reducing the deficit seems nearly impossible. This will force the Treasury Department to issue large volumes of debt, which, when combined with similar actions by other countries, will flood the market. The increased supply of bonds will create pricing competition, and as bond prices drop, yields will rise.
2. Decreased foreign interest in Treasurys: Countries like China and Japan have been reducing their holdings, leading to diminished demand. This reduced demand, alongside the increased supply of bonds, will lower bond prices and drive yields higher.
3. A healthy U.S. economy: There is little indication of an imminent recession, meaning the economy is unlikely to cool down enough to reduce yields.
4. Potential for inflation: While the Fed expects inflation to cool to 2% by 2027, tax cuts could inject too much capital into the system, raising prices. Additionally, tariffs could have a regressive effect, making goods more expensive.

However, there are two factors that could temper this outlook:

1. Fed bank regulation guidance: New regulations could boost demand for Treasurys by banks, which might absorb some of the slack in demand, supporting prices and controlling yields.
2. Political uncertainty and Fed actions: The political landscape has cleared with the upcoming election, and there are concerns about the Fed becoming less independent. This could encourage the central bank to slow or even stop quantitative tightening, potentially restarting bond purchases.

Despite these counterarguments, Husain concludes that longer-term Treasury yields are likely to rise, steepening the yield curve as the economic and fiscal conditions continue to evolve.

 

Source:  GlobeSt.