The Federal Reserve's recent interest rate cuts have not led to the expected decrease in longer-term Treasury yields, posing a challenge for Fed Chair Jerome Powell. This situation mirrors a past conundrum faced by former Fed Chair Alan Greenspan, who saw minimal impact on long-term rates despite significant hikes in overnight interest rates.
The Fed reduced its policy rate target by 75 basis points since September, with an initial 50 basis point cut followed by another 25 basis point reduction. However, the 10-year Treasury yield has increased by nearly 80 basis points during this period, reaching around 4.50 percent.
Rising yields have been attributed to improved economic data and potential policies from the incoming administration, with the Republican Party retaining control of the House. Powell has refrained from speculating on future policy impacts, stating, “Here, we don’t know what the timing and substance of any policy changes will be. We therefore don’t know what the effects on the economy would be.”
Market speculation suggests that better economic data is leading to fewer anticipated rate cuts from the Fed. Of the rise in Treasury yields since September, about 50 basis points are linked to this adjustment in expectations. Inflation expectations have also contributed to rising yields, with market forecasts for inflation increasing from 2.05 percent to 2.35 percent over the next decade.
Donald Trump's return to office reflects a global trend against inflationary pressures that have unseated incumbent governments worldwide. Ironically, those voting against inflation may face more of it due to current market expectations.
Higher Treasury yields could lead to increased borrowing costs and stress housing affordability as mortgage rates climb toward multiyear highs. For investors, however, higher lending rates might offer attractive returns in fixed income markets.
Policymakers at the Fed may find limited options to counteract rising yields without exacerbating inflation fears. Should economic growth remain strong and deregulation continue under new policies, further rate hikes could occur in late 2025.
Thomas Garretson of RBC Wealth Management notes that while growth optimism persists, fixed income markets signal potential costs associated with these developments.