Fed and bond yields

The Fed cut rates again today and the 10-year Treasury yield ticked up ahead of the event. This decoupling is really no mystery. The Fed’s cuts this year will stimulate the economy at the same time as the Trump Administration’s fiscal policy is providing new stimulus. Meanwhile, the supply of labour has been restrained by tight immigration control, with potential inflation risks. The Fed expects stronger growth next year and so do many forecasters. It’s no surprise then that bond yields are not following the Funds rate down.   

The notion that the Fed cannot control bond yields is engrained in financial media and markets. The example often used by pundits on financial shows is that US bond yields rose after the September 2024 rate cut.

The daily chart of the US 10-yr. note yield below shows that activity in 2024 ahead of the Fed  rate cut was pretty choppy. Bond yields had fallen from the October 2023 push above 5%. They troughed near 3.8% in December 2023, then popped higher to near 4.75% in April 2024 as US economic data continued to hold up. Remember that many economists were looking for the US economy to ‘turn turtle’ for some time by then, and had been disappointed by the general robustness in the data. The Fed started to take note of the softening labour market in May 2024 (unemployment rate rose to 4%) and then the Sahm rule kicked in in July 2024. The Fed Chairman buckled in August at his Jackson Hole speech and laid out the grounds for the September rate cut. 

The fact that the bond yield rose from nearing 3.6% ahead of the rate cut turned out to be a case for the history books in how markets can ‘buy the rumour, sell the fact’. Or, to paraphrase Robert Louis Stevenson, ‘to travel hopefully is a better thing than to arrive’.   

Bond yields had fallen by over 100 bp before the event, bond yields ended up touching 4.8% after the event. Why? The US economy continued to refuse to fall over. The Biden administration goosed the economy by spending over $1.9 trillion in various acts and packages. Many of these infrastructure projects took a long time to develop, keeping their economic impact ticking along. The Trump administration goosed the economy with the extension of tax cuts and new measures in the ‘One Big Beautiful Bill Act’. This has the Atlanta Fed’s GDPNow tool projecting Q3 GDP to come in at 3.5% (annualised).  

So, while the Fed has lowered rates by cutting the fed funds rate today and might cut again next year, this may only drag down the 2-yr. note yield and have a drag on the shorter end of the curve. The 10-yr. note and longer-dated bonds may look at the fed rate cuts, along with the Trump measures that are expected to boost economic activity, weight the drag on growth from tariffs and flip a coin on the inflation impact, and vote to keep bond yields in a range. The weekly chart below suggests that bond funds may be busy playing the range for a while. Panic on sustained pressure above 4.8% or 5% in the 10-yr. note yield as the next area of resistance may be 5.3% and 6% or so. Take note if the yield falls below 3.8% and 3.6% as 3.3%/3.0% are the next areas of support.

Gerry Celaya, Chief Strategist