The Thirty-Year Hit 5.63%, Its Highest Since 2002, on a Day Inflation Came In Cool

The thirty-year Treasury yield reached 5.63% on September 30, the highest level since June 2002 and the seventh consecutive session of increases, the longest such run in two years. The ten-year sat at 5.26%.

What makes the move worth studying is the data it ignored. The same morning, the Federal Reserve's preferred inflation gauge came in below expectations across the board: headline personal consumption expenditures inflation at 3.4% against a 3.7% forecast, and the core measure at 3.0% against 3.3%. A bond market selling off on cooler inflation is telling you it is pricing something other than inflation.

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What a long bond actually prices

A thirty-year Treasury yield is three things stacked together: the average short rate investors expect over thirty years, plus compensation for inflation they cannot forecast, plus a term premium, which is the extra return demanded simply for tying money up that long instead of rolling short paper.

The first two components got better this week. The third is where the action is. Term premium is not a forecast of anything; it is a price for accepting duration risk, and it rises when the supply of long bonds grows faster than the appetite to hold them. Federal debt is above $40 trillion, the Treasury continues to issue heavily at the long end, and the Federal Reserve is shrinking rather than expanding its holdings.

The official response tells you the same story. The Treasury raised its buyback capacity for bonds in the ten to twenty year part of the curve to $6 billion, triple the $2 billion ceiling that had been in place before September. Buybacks are a liquidity tool rather than a rescue, but you do not triple one because the market for your paper is comfortable.

What this does to anyone who owns duration

Whitmore's Watchlist:
VGLT (Vanguard Long-Term Treasury ETF): Long dated government paper, the cleanest expression of what just happened.
EDV (Vanguard Extended Duration Treasury ETF): Stripped Treasuries with even more duration, where the same yield move is amplified.
VCLT (Vanguard Long-Term Corporate Bond ETF): Long corporate credit, which carries this duration plus a spread.

The most widely held long Treasury fund closed at a record low on the same day the yield peaked. That is worth sitting with, because the two facts are the same fact seen from opposite ends: a bond's price and its yield are mechanically inverse, and a thirty-year bond loses roughly 18% of its value for every one percentage point rise in yield.

Investors who bought long Treasuries in 2020 for safety have now taken an equity-sized drawdown in the asset they owned specifically to avoid one. Nothing went wrong with the credit; the United States has paid every coupon. The loss is entirely a repricing of time, which is the risk long duration was always compensating for and which few were thinking about when the compensation was 1.5%.

The other side of that arithmetic is the part worth noticing now. At 5.63%, a thirty-year Treasury locks in a nominal return above the long-run average of United States inflation, with no credit risk and no reinvestment risk, for a generation. The buyer today is not the investor nursing the loss; the two are simply arriving at different prices.

What would actually turn it

Three things would end this move, and an inflation print is not obviously one of them, as this week demonstrated.

The first is issuance. A shift in the Treasury's borrowing toward bills reduces the amount of duration the market has to absorb. The second is a buyer of size returning, whether that is foreign official demand, pension funds extending duration into the higher yields, or eventually the central bank. The third is a growth scare, which is the only one that works quickly and the only one nobody should want.

Until one of those arrives, the pattern of the last month holds: the front end responds to the Federal Reserve and the long end responds to the deficit, and the two can move in opposite directions on the same day without either being wrong.

For portfolio purposes that division is the useful takeaway. Short duration is a bet on policy. Long duration is a bet on fiscal arithmetic and on who is willing to fund it. They are not the same trade, and owning a broad bond index means owning both without having chosen either.

Whitmore's Take: A long bond selling off into cooler inflation is a supply and demand statement, not an inflation statement. Worth knowing how much duration sits inside your bond allocation, because at these yields that single number explains most of what it does next.

Disclaimer
The content in this email does not constitute an offer or solicitation to buy or sell any financial instrument. All commentary is general in nature and is not directed at any individual investor.

Written by Daniel Whitmore
Millionaire Insiders