⚡️Market Strategy Flash
May 29, 2026
In my June 4, 2025, Market Strategy Flash, “Why bond yields have increased around the world,” I argued that rising yields were driven by improving investor risk appetite as expressed by more demand for “pro-cyclical” assets (i.e., stocks) and less demand for “defensive” assets.
This week, I evolve the narrative from simply explaining why bond yields are higher in 2026 to a discussion about why their current levels may be healthy and sustainable, and why the Federal Reserve (Fed) should adopt a “do no harm” policy.
1. Rate Risk – In standard economic theory, sovereign or government bond yields have two components: a) Expectations for the future path of short-term interest rates; and b) the “term premium,” which is the compensation investors require for taking the risk that interest rates may change over the life of the bond. Mathematically, the US Treasury “term premium” is equal to the 10-year US government bond yield minus the average expected federal funds rate over the next 10 years. Conceptually, the “term premium” – which has risen sharply – is a nebulous “catchall” for a variety of different forces unexplained by monetary policy (e.g., supply, inflation, real growth, expected volatility).
Unfortunately, the bond “vigilantes” and “inflationistas” have “weaponized” the “term premium” as a sinister source of the backup in bond yields year to date (YTD). In my view, this isn’t a Fed “freak-out” or an inflation “scare.” It’s a “normalization” of the compensation investors demand for holding long-duration assets.
Investors require an extra 0.8 ppts for taking interest-rate risk
Sources: FRED, WCG, 5/26/26. Notes: Real = Inflation adjusted. Breakeven = The nominal yield minus the real yield or the market-implied 10-year expected inflation plus an inflation risk premium. Indices are unmanaged and cannot be invested in directly. Past performance does not guarantee future results.
Decomposition – Beneath the surface, the YTD increase in the 10-year Treasury yield has been spurred by a repricing of “duration” risk, not policy “panic:”
- 4.6%: The “nominal” 10-year Treasury yield has “choked up” by 9% YTD (read: bond prices have fallen), mirroring the S&P 500 rally in the same time frame (read: stock prices have risen).
- 0.8%: The “term premium,” which has surged over 45% YTD, has been mislabeled as the “bad actor” in the bond market drama. In other words, investors now require an extra 0.8 percentage points (ppts) to buy and hold a 10-year Treasury as opposed to buying and holding 1-year Treasuries each year for the next 10 years.
- 2.2% & 2.4%: By comparison, the “real” yield and the “breakeven” inflation rate have experienced modest moves of 12% and 7% YTD, respectively.
Key Takeaway – The Treasury selloff is largely explained by the “term premium,” an often-misunderstood expression that captures supply, inflation, real growth and expected volatility. However, investors are just asking for some extra yield to compensate them for bearing interest-rate risk, rather than bracing for restrictive monetary policy (see the chart above).
2. Underwriting Growth – Sovereign bond yields have continued their global ascent, but the story line is one of economic resilience, not distress. While bond yield backups can trigger market anxiety, my research shows the cost of money is reasonable and supportive of economic growth.
Mind the Gap – The spread between 6.0% year-over-year (Y/Y) nominal gross domestic product (GDP) growth and a 4.6% 10-year Treasury yield demonstrates that the current level of market interest rates is supportive, not restrictive, of business and consumer activity.
Key Takeaway – Given a 10-year Treasury yield that rests 1.4 ppts below nominal GDP growth, financial conditions remain accommodative. From my lens, the economic and earnings expansion has plenty of runway, provided our central bank’s primary mandate is: Do no harm (see the chart below).
The cost of money is reasonable and supportive of economic growth
Sources: BEA, FRED, WCG, 5/26/26. Notes: NBER = National Bureau of Economic Research. GDP = Gross domestic product. Indices are unmanaged and cannot be invested in directly. Past performance does not guarantee future results.
3. Valuation Anchor – Despite the fear mongers’ bearish narratives, the underlying trend in core inflation suggests that the 10-year Treasury isn’t a ticking time bomb. Rather, intermediate-term US government bonds sit squarely in “fair value” territory.
- “Fair” Value: My simple 10-year Treasury model – a statistical regression based on the 10-year moving average of the Y/Y % change in the Consumer Price Index (CPI) Less Food and Energy – estimates “intrinsic” value at 5.0%.
- Current Level: With yields hovering below 4.6%, US government bonds are trading well within their minus/plus one standard error band of 3.6% (overvalued) to 6.3% (undervalued).
Key Takeaway – For those worried that domestic fixed-income markets are overextended, my straightforward 10-year Treasury valuation model should provide some reassurance (see the chart below).
10-year Treasury yields seem fairly valued
Sources: BEA, BLS, FRED, WCG, 5/26/26. Notes: SE = Standard error. Indices are unmanaged and cannot be invested in directly. Past performance does not guarantee future results.
Bottom Line – When interest rates find a new “equilibrium,” it’s a feature – not a bug – of price discovery, a dynamic marketplace, less government intervention and a brighter economic outlook. More importantly, businesses and consumers can better afford the cost of money when it’s below the pace of nominal GDP growth and aligns reasonably well with long-term inflation trends. In my humble opinion, we’re at a critical juncture where the Fed doesn’t need to slam on the monetary brakes … it needs to let our growth engine run.
Recent and relevant Market Strategy Flashes:
Why bond yields have increased around the world, June 4, 2025
Definitions
Gross Domestic Product (GDP): The total value of goods and services produced within an economy over a specific period.
Dynamic Random Access Memory (DRAM): A type of semiconductor memory commonly used in computers, servers, smartphones, and other devices to temporarily store data that can be accessed quickly.
Random Access Memory (RAM): Short-term computer memory used to store data that a device is actively using.
DDR3, DDR4, and DDR5: Generations of double data rate DRAM. Newer generations generally provide higher speed and/or improved power efficiency compared with older generations, although performance varies by configuration and use case.
Graphics Processing Unit (GPU): A processor designed to handle parallel computations. GPUs are widely used in graphics, artificial intelligence, machine learning, and other compute-intensive workloads.
GPU compute: The use of GPUs for processing workloads beyond traditional graphics, including artificial intelligence and machine learning applications.
High Bandwidth Memory (HBM): A higher-performance form of memory designed to provide very high data-transfer bandwidth, commonly used with advanced AI accelerators and other high-performance computing applications.
HBM3E and HBM4: Generations of high bandwidth memory used or expected to be used in advanced computing applications. HBM4 is generally expected to be a newer generation than HBM3E.
Hyperscalers: Large cloud-computing and data-center operators with significant infrastructure needs.
Secular demand: A long-term demand trend that may persist across multiple business cycles.
Cyclical: A pattern tied to the ups and downs of an economic, inventory, or industry cycle.
Super-cycle: An unusually long or powerful industry cycle, typically driven by strong demand, constrained supply, or both.
Risk budget: A framework for determining how much portfolio risk is appropriate relative to an investor’s objectives, constraints, and guidelines.
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Publication Date: May 29, 2026
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