US government bond yields may soon climb toward their recent peak as inflation remains stubbornly above the US Federal Reserve's target, the labor market shows little sign of cracking and expectations for cuts to benchmark interest rates are diminishing.

The benchmark US Treasury 10-year yield approached 4.5% early April 10 following the release of hotter-than-expected consumer price index data, extending a climb up from a recent trough near 2023-end. The yield, which moves opposite prices, peaked most recently at 4.98% on Oct. 19, 2023, its highest level since 2007. It fell to 3.79% on Dec. 27, 2023, as expectations for interest rate cuts in 2024 ramped up amid falling inflation data and forecasts for a slowing labor market and wage growth.

So far this year, however, inflation has failed to fall much further, the unemployment rate has held near historic lows and the economy has continued to grow, boosting the likelihood that relatively high interest rates, in place since the Fed last hiked in July 2023, will likely stay in place for far longer than most predicted just a few months ago. Fixed income strategists believe if the domestic economy continues to run hot, the higher yields near that October 2023 peak could soon be within reach.

"There is potential for the 10-year yield to climb to 5%," said Althea Spinozzi, head of fixed income strategy at Saxo Bank. "For this to occur, we would need a scenario similar to that of last year: persistent inflation and an economy growing at or above trend."

The path to 5%

As rate cut prospects have fallen, longer-duration government bond yields have soared and likely will continue to rise unless inflation soon shows signs of significant cooling.

How much longer the sell-off in bonds lasts depends on the direction of the economy and expectations for monetary policy.

"I think to see 5% again on 10-year yields you would need to see either a full-blown reacceleration of inflation or another round of worries about higher deficits," said Gennadiy Goldberg, head of US rates strategy at TD Securities. "In particular, given that the Fed has been clear that investors should focus more on prices than on labor markets and growth, I think it would be an acceleration in inflation that would drive rates back to 5%."

Personal consumption expenditures excluding volatile food and energy prices (core PCE), an inflation metric watched closely by the Fed, fell to just under 2.8% annual growth in February, according to the latest government data. While this is well below the peak of just under 5.6% in February 2022, the decline in growth has slowed since the end of 2023.

"Core PCE is still running low and the leading indicators of it are signaling a continued declining trend," said Kathy Jones, managing director and chief fixed income strategist for the Schwab Center for Financial Research.

If inflation were to see a significant upshift and expectations for Fed policy shifted markedly, the 10-year yield would likely rise to 5%, Jones said.

It is unusual for 10-year yields to rise substantially after the Fed has stopped hiking rates, but this has been a unique cycle for the Fed, and this may be another in a long list of differences for this post-pandemic monetary policy push, Jones said.

If the Fed signaled that there would be no rate cuts this year, it would cause the 10-year and other longer-tenor yields to move higher, further steepening the yield curve as yields on long-term bonds rise faster than those of shorter-term bonds, Jones said.

"That's not our base case but a possibility based on comments from some Fed officials," Jones said.

Key recession signal may yet prove true

The yield curve has been inverted since July 2022, one of the longest periods of inversion on record and typically a recession signal.

"Typically, the inversion of the curve is consistent with cuts at some point after inversion," Goldberg with TD Securities said. "Markets also take it as a signal of recession, but the curve is not a perfect indicator of recession."

Still, a recession may yet be possible as higher interest eventually start to wear on the economy. If that happens, the inversion will be seen as an accurate indicator.

"Clearly, it anticipated it too soon, and the deep and protracted inversion suggested quite a deep and protracted recession, which we may not get," said Padhraic Garvey, regional head of research, Americas, with ING. "I'd suggest the prior aggressive [quantitative easing] messed things up, and things just look different this time around post the pandemic sugar high."