While the stock market has plowed higher for much of the past decade, all eyes have turned to the bond market in recent years.
Following the Great Recession, the Federal Reserve cut interest rates to zero for roughly a decade to stimulate the economy after trillions in wealth got wiped out. But high inflation following the COVID-19 pandemic forced the Fed to raise interest rates.
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This year, surging oil prices as a result of the Iran war and a renewed focus on mounting U.S. debt sent longer-dated bond yields soaring. The yield on the 10-year U.S. Treasury note is now 5.18%, while the yield on the 30-year is around 5.5%.
Yields haven’t been this high since right before the Great Recession. Here’s what history says comes next.
High interest rates contributed to the housing market collapse
At the center of the Great Recession was the collapse of the housing market. Banks and other mortgage lenders made too many subprime mortgage loans, believing that the housing market would never decline in value.
As such, lenders granted loans to borrowers who didn’t have the means, many of which were made with no money down or without verifying the borrowers’ income or assets. Banks would package the loans into mortgage-backed securities (MBS) and then repackage them into collateralized debt obligations (CDOs), so lenders could keep lending.
Many of these borrowers also took out adjustable-rate mortgages (ARMs), which began with low teaser rates and then reset to much higher rates after a few years, significantly increasing their mortgage payments. These ingredients became an explosive combination during the Great Recession, when the housing bubble finally burst, and many borrowers lost their homes.
Large banks and lenders holding these MBS and CDOs were sitting on enormous losses, and some, like Lehman Brothers, even collapsed or were acquired in emergency deals organized by the U.S. Treasury Department.
While the main issue behind the crisis was bad mortgage loans, rising rates and yields contributed to the collapse. For one, the 10-year note is directly correlated to mortgage rates.
10 Year Treasury Rate data by YCharts
The Fed raised its benchmark overnight lending rate, the federal funds rate, multiple times in 2006 to cool the economy, a move that also influences longer-term yields. This, in turn, raised ARM rates, making it difficult for subprime borrowers to make their mortgage payments.
