Rising Yields Put Pressure on Fed’s Rate Cut Plans
The US government bond market is experiencing a significant sell-off, with two-year yields climbing 34 basis points since the Federal Reserve reduced interest rates on September 18. This move is reminiscent of the 1995 rate cut cycle, when the Fed, led by Alan Greenspan, successfully cooled the economy without triggering a recession.
A Resilient Economy Limits Fed’s Options
The latest backup in yields reflects a resilient US economy and buoyant financial markets, which are limiting the options for Fed Chair Jerome Powell to aggressively lower rates. Interest swaps show traders are expecting the Fed to lower rates by 127 basis points through September 2025, compared with 195 basis points priced in about a month ago.
Rising Yields Reflect Reduced Recession Risks
According to Steven Zeng, an interest rate strategist at Deutsche Bank AG, rising yields “reflect the reduced probability of recession risks.” The Fed may slow the pace of rate cuts as data has come in strong. The recent rise has brought the yield on the benchmark 10-year Treasury to around 4.2%, up from a 15-month low of 3.6% on September 17.
Market Sentiment Remains Bearish
Trading activities suggest that sentiment remains bearish, with a series of sales of block trades in 10-year note futures. In the options market, one trade targets the 10-year yields rising to about 4.75% by the option expiry on November 22. The ICE BofA Move Index, which tracks expected swings in Treasuries in the coming month, has climbed to the highest level this year.
Growing Concerns About Inflation and Deficit
Rising yields also reflect growing concern that the Republican Party could take control of both the White House and Congress in the November 5 election, potentially boosting the federal deficit and inflation. Volatility has picked up, and the recent rise in yields has brought the total return in Treasuries to just 1.7% this year, trailing the 4.3% gain in T-bills.
A Challenging Environment for the Fed
The current environment is challenging for the Fed, as it tries to balance the need to support the economy with the risk of inflation and a growing deficit. The Fed’s next move will be closely watched, as it navigates this complex landscape.
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