After a blistering start to the year, Treasury yields have retreated from one-year highs to one-month lows even as the incoming economic data had a blistering start to April.

First there was the ISM Manufacturing Purchasing Managers’ Index (PMI) on Apr. 1 that showed the largest uptick in activity since 1983. That was then followed by the jobs report that showed nearly one million jobs added in March. Not to be outdone, the Service Sector PMI, on Apr. 5, showed activity running at the strongest level on record, dating back to 1997. Then this week we saw the headline Consumer Price Index pop to 2.6 percent year over year, and though largely fueled by weak prices this time last year, this is another sign that continues to point toward building inflationary pressures, in our opinion. Finally, stimulus-fueled retail sales data this week was off the charts, up nearly 10 percent month over month.

So, since reaching 1.75 percent at the end of March, the benchmark U.S. 10-year Treasury yield has slipped back to nearly 1.50 percent, seemingly putting the “rising rate” narrative firmly on the back burner, at least for the time being.

So what gives?

Surveying the landscape of traders and analysts this week looking for explanations, we think one thing is clear—no one really has any.

The easiest explanation might just be that after the torrid start to the year, yields were inevitably due for a period of consolidation. Foreign demand for U.S. bonds has also picked up notably in recent months, while the start of earnings season typically brings a glut of new corporate bond issuance—which tends to drive demand for Treasuries and hedging. The Fed continues to push back against the idea that rate hikes are anywhere on the horizon, with Fed Chair Jerome Powell stating this week that the conditions necessary for liftoff are highly unlikely before the end of 2022, let alone this year.

On top of Powell pushing back against the market’s recent expectations regarding rate hikes, he also continues to signal that near-term inflationary pressures will only be transitory, and that downside risks over the long term remain. As the chart shows, the spike in the Consumer Price Index this week to 2.6 percent is expected by RBC Economics to crescendo near 3.6 percent this quarter before falling sharply back to more stable levels.

Jump in consumer prices still seen as temporary
Line graph of Jump in consumer prices still seen as temporary

The line chart shows the recent trend in the Consumer Price Index year-over-year change since 2018 and the expected jump to 3.6% in the second quarter this year, which is then expected to slow to re-normal levels around the Fed's 2% target through 2022.

Consumer Price Index (y/y)
RBC forecast

Fed's 2% target

Source - RBC Wealth Management, RBC Economics, Bloomberg; data as of 4/14/21

But maybe it just comes down to the classic explanation that markets—being forward-looking as they are—had already priced in a lot, if not all, of the good news and stimulus that we have seen of late, with traders now awaiting any catalyst that might be cause to take yields to the next leg higher.

Not all rising rate environments are the same

While global yields are moving lower this week, the fear around rising rates continues to be front of mind for investors and portfolios, with this recent pullback only likely to amplify the issue should yields resume their march higher.

And higher yields remain the base case, in our view. This month, RBC Economics upgraded its economic and rate forecasts, as did most analysts, with our colleagues now seeing the 10-year Treasury yield rising to 2.05 percent, up from 1.85 percent previously, by this time next year.

But what does this actually mean for bond prices and portfolio performance? With all of the moving parts in fixed income securities, things can get pretty murky, pretty quickly. At a high level, higher yields mean lower bond prices, but by how much, and how much coupon income is needed to offset declines in bond prices?

The table shows how bonds are likely to perform over the next year based on RBC Economics forecasts for the 2-year, 10-year, and 30-year Treasury yields. But higher Treasury yields don’t necessarily translate exactly to other sectors. Muni bond yields are likely to remain less sensitive to movements in Treasury yields as investor demand is likely to remain elevated amid the risk of higher tax rates. Corporate bond yields will also rise in sympathy with Treasury yields, but to a lesser extent.

Scenario analysis: What impact does “rising rates” have on bond prices and portfolio performance?
Security type Maturity Coupon Current yield Current price Q2 2022 forecast yield Q2 2022 forecast price Yield change Price change Coupon income One-year total return
Treasuries 2Y 0.1% 0.16% $999 0.90% $994 0.74% -$5 $1 -0.4%
10Y 1.1% 1.61% $962 2.05% $931 0.44% -$31 $11 -2.1%
30Y 1.9% 2.30% $926 2.60% $861 0.30% -$65 $19 -5.0%
Investment-grade corporates 2Y 0.8% 0.61% $1,004 1.30% $993 0.69% -$11 $8 -0.3%
10Y 2.6% 2.46% $1,011 2.85% $984 0.39% -$27 $26 -0.1%
30Y 3.6% 3.41% $1,028 3.60% $1,001 0.19% -$27 $36 0.8%
Municipals 2Y 5.0% 0.08% $1,121 0.45% $1,071 0.37% -$50 $50 0.0%
10Y 4.0% 0.94% $1,177 1.19% $1,139 0.25% -$38 $40 0.2%
30Y 4.0% 1.87% $1,178 2.12% $1,145 0.25% -$33 $40 0.6%

Source - RBC Wealth Management, RBC Economics; data through 4/14/21

And, for the most part, the damage is actually minimal. Outside of Treasuries, the decline in bond prices due to higher market yields is more than offset by the interest earned from coupons over that one-year period. For example, if the 10-year Treasury yield rises to 2.05 percent, the price falls by $31, which isn’t offset by the $11 in coupons. A comparable 10-year corporate would see its price fall by $27, nearly fully covered by $26 in coupons, and it’s a similar story for municipals. And longer-dated securities may actually offer investors attractive value around current levels.

So the outlook may not be as bleak as feared by many fixed income investors, particularly as we believe any further rise in yields is likely to be more gradual than we have seen in recent months.

This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.

The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.

This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.

Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.

We want to talk about your financial future.