There's no doubt that the rise in energy prices has impacted inflation numbers in the near term. However, rising energy prices alone don't explain the rapid increase in yields further out on the curve.

Treasury yields have shot up to their highest levels in nearly two decades, with the 10 YR Treasury Yield Index (TNX) hitting 5.35% earlier this month. Most headlines attribute the rise in yields to inflation worries — specifically, the Fed's efforts to wrangle inflation back to target in the aftermath of the early 2020s inflation wave, alongside a recent boost in energy prices tied to the ongoing conflict in the Middle East. There's no doubt that the rise in energy prices has impacted inflation numbers in the near term. However, rising energy prices alone don't explain the rapid increase in yields further out on the curve. In fact, the 10-Year Breakeven Inflation Rate is lower than it was in May when TNX was just under 4.60%. Breakevens are important to consider because they are what investors expect inflation to be over whatever period is being observed. In other words, there is money on the line, whereas investor surveys are all talk, and talk is cheap. In the chart below, the 10YR Treasury Yield and the 10-Year Breakeven Inflation Rate are presented with data going back to 2003. The average 10-Year Breakeven rate over that period is also displayed by the dotted horizontal line.

The 10-Year Breakeven has oscillated between 2% and 2.5% over the last few years and has not moved higher out of this range despite nominal yields rising to their highest levels in nearly 20 years. If inflation expectations aren't driving the recent rise in yields, then real yields must be. We can approximate real yields by looking at the spread between the 10YR yield and the 10YR Breakeven Rate (shown in the image below). Real yields are now just shy of their late-2008 highs. The last few years have also marked the highest real yield period since before the GFC, although one could argue that the low real yields following the GFC were historically unnatural. Nonetheless, it does appear that most of the increase in yields can be attributed to an increase in real yields. These higher real yields, particularly since they are at levels not seen in 20 years, signal tighter financial conditions and increase investor propensity to save rather than spend. Put more plainly, at some point, the "guaranteed" return from Treasuries becomes too good for investors to pass up. We've seen this trade-off in the annuity space, where sales have exploded due to higher interest rates making them more attractive. According to LIMRA, annuity sales for the first half of 2026 set a new record (Source: LIMRA).

As real yields push higher, investor behavior shifts, with demand for fixed income naturally increasing. Looking at other instances when the real yield crossed above 2.50%, excluding clusters within six months, forward returns for both equities and fixed income were, on average, quite strong over longer time frames. However, a few of these instances occurred in the lead-up to or during the GFC, when equity markets were far weaker than the return snapshots suggest. Secondly, the 40% one-year return coming out of October 2023 skews the average quite a bit. Overall, it's a mixed bag in terms of forward equity performance. Moving over to fixed income returns, they are consistently quite strong on a total return basis. It's admittedly a small sample size, but it does appear that when real yields reach these levels, there is more demand for fixed income securities. On a technical basis, the Ten Week For US All Fixed Income Quality (^TWMUUSFIXEDALL) is below 10%, which has been a favorable setup for the Bloomberg Barclays US Agg Total Return Value Unhedged USD Index (LBUSTRUU) as the one-year return has been positive just under 85% of the time with data going back to 2003. Overall, fixed income is still an asset class worth underweighting for the time being until some more strength comes into the picture. However, the combination of a short-term technical washout and the most attractive real yields in two decades could stabilize the reeling asset class moving forward.