Lofty Real Rate Expectations
5 Year forward yields reached 4.7%, the highest since 2007, driven by rising real rates amid stable inflation near the Fed's 2% target. This reflects market optimism for economic fundamentals but signals higher borrowing costs and potential growth challenges.
5 Year, 5 Year forward rates are market derived yields that indicate what the market is expecting the 5 Year yield to be, five years from now. This perspective looks to capture what the 5 Year yield might be once the economy stabilizes in the coming 5 years.
In the chart above we plot nominal forward yield expectations, along with the inflation and real yield components. Current nominal 5 Year, 5 Year forward yields are at 4.7%. Outside of the recent inflation surge, we have not seen 5 Year yields reach this level since back in 2007! Further, notice that inflation expectations are relatively flat, right around the Fed’s target of 2%. Despite this stable inflation outlook, nominal bond forward yield expectations are rising. This mainly comes from the rise in real rate expectations.
From an optimistic perspective, rising real rates can indicate market confidence in future economic growth. Investors may anticipate that economic fundamentals will support higher real yields. On the other hand, higher real rates may represent a larger risk premium investors demand for higher levels of government debt. Higher real rates also mean higher borrowing costs for all, a headwind to overall growth. In the end, market expectations are for something quite different than we saw before the pandemic, and what we saw throughout the 2010s.