The financial landscape has been a spectacle of surprises and resilience, as U.S. government bond yields have undergone a dramatic surge, reminiscent of a historical precedent set in the early 1980s.

The 10-year Treasury yield, a pivotal benchmark in determining the cost of money across the financial system, has witnessed an increase of over four full percentage points within a span of three years, briefly surging above 5% this week for the first time since 2007. This notable rise represents the most significant increase since the era of Paul Volcker, where aggressive monetary policies were implemented to curb inflation, ultimately resulting in the 10-year yield nearing 16%.

At the helm of this monetary turbulence is Fed Chair Jerome Powell, whose interest rate hikes have been paralleled to those of Volcker’s time. However, despite the aggressive nature of these hikes and the potential historical repercussions, the U.S. economy has displayed an uncanny resilience, defying gloomy forecasts and even showing signs of growth in the third quarter, according to estimates from the Atlanta Fed.

The contrast between the current economic climate and that of the 1980s is stark. In the era of Volcker, monetary policies were considerably more restrictive, with the “real” 10-year Treasury yield (adjusted for consumer-price increases) sitting at around 4% during the onset of the second downturn in mid-1981. Fast forward to the present day, and the “real” yield is hovering around 1%.

This surprising economic fortitude has consequently injected a substantial amount of uncertainty into the markets. Bond yields have surged sharply in recent months, driven by a growing conviction that the Fed will maintain its stance on high interest rates. As the market grapples with this uncertainty, billionaire investor Bill Ackman has opted to close his bearish bets against long-term bonds, citing a rapidly slowing economy as his rationale.

The beginning of the year painted a different picture, with numerous calls for a bond market rally as speculations mounted that the Fed might change its course. Contrary to these expectations, bond prices have continued their downward trajectory.

The Bloomberg US Treasury Total Index has depreciated by approximately 2.6% this year, extending its losses since August 2020 to a staggering 18%. To put this into perspective, the most severe peak-to-trough drawdown prior to this was a 7% decline in 1980, when the Fed’s key benchmark reached 20%.

The selloff in bonds has been particularly painful due to the prolonged period of low rates, which has dampened the income payments that typically help to mitigate losses. Additionally, a sharp increase in the federal deficit has led to an influx of new Treasuries in the market. This has occurred concurrently with a pullback in bond buying from traditional heavyweights such as the Fed and other major central banks. This combination of factors has played a pivotal role in driving yields higher in recent weeks, despite the futures market indicating that traders believe the Fed’s rate hikes have reached their terminus.

As we navigate through this tumultuous financial landscape, Priya Misra, a portfolio manager at JPMorgan Asset Management, highlights the prevailing uncertainty, noting that while a “hard landing” is anticipated, clear indicators of an impending recession remain elusive. “Conviction levels are low,” she remarks, reflecting the sentiment of investors who have been stung by the recent bond market movements.

The question now stands: can the U.S. economy sustain its resilience amidst the surging bond yields, or are we on the brink of a repeat of history, with potential recessions looming on the horizon? Only time will tell, but what is certain is that the financial world will be watching closely, poised for the challenges and opportunities that lie ahead.

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