Since Donald Trump's election as U.S. President in November last year and the Federal Reserve's December indication of a slower pace of rate cuts, the yield on the 10-year U.S. Treasury bond has been steadily climbing. As of January 9, it has surpassed 4.7%, marking its highest level since April 26, 2024. Some Wall Street analysts are already predicting the possibility of a return to 5% yields.

How should we interpret the ongoing and unexpected rise in U.S. bond yields? In this article, we will deconstruct the components of long-term U.S. bond yields and explore the factors contributing to their recent surge.

1. Components of US Long-Term Bond Yields

Former Fed Chairman Ben Bernanke proposed three major components of US long-term bond yields in 2014: inflation expectations, real interest rate expectations, and term premiums. Each of these elements can be observed by break-even inflation rates (BEIR), yields on Treasury Inflation-Protected Securities (TIPS), and the ACM term premium estimates. These indicators provide insights into the dynamics of US bond yields.

2. Three Key Components

Breakeven inflation rate: This is the yield difference between US bonds and TIPS. When the breakeven inflation rate trends upward, it reflects market expectations of rising inflation, driving US bond yields higher, and vice versa.
TIPS: Treasury Inflation-Protected Securities adjust their principal and interest based on the Consumer Price Index (CPI) to provide protection against inflation. TIPS yields can thus represent real interest rates and can be used to observe changes in market expectations about the economy.
ACM term premium estimate: Term premiums refer to the additional return required by investors for holding longer-term bonds. Term premiums are the difference between the return investors gain by holding bonds with extended terms and by investing in the short-term bonds for the same total amount of time.

Takeaway from MacroMicro

All three components of U.S. Treasury yields are rising simultaneously. TIPS (Real Rate) and Breakeven Inflation have both reached their highest levels since May 2024, while the ACM Term Premium has risen even further, hitting its highest point since 2015. This upward movement reflects several factors: stronger-than-expected economic growth is pushing the real rate (TIPS) higher, revised inflation expectations from the recent FOMC meeting are driving up the breakeven inflation rate, and increased uncertainty—stemming from Powell’s hints at slower rate cuts and concerns over the potential impact of “Trump 2.0”—has led to a higher term premium as investors demand additional compensation for risk.

While “Trump 2.0" adds more uncertainty, MicroMicro’s previous analysis suggests that the inflationary impact of tariff risks may be lower than the market anticipates. Looking ahead, a critical factor will be whether the Federal Reserve can successfully slow or halt its balance sheet reduction this year. If this occurs, it could alleviate pressure on U.S. Treasuries, creating the potential for yields to reach their peak.

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