Despite the Federal Reserve’s aggressive interest rate cuts, long-term bond yields climbed higher. Here’s why.
On Wednesday, the Fed made its first significant move in four years, cutting short-term borrowing costs by 0.5%, bringing the target range to 4.75%-5%. This marked the central bank’s first rate cut since 2020.
However, the market’s response was less than enthusiastic. Longer-term Treasury yields, which influence key financial products like mortgages and auto loans, edged up from their recent lows. Higher yields indicated that Wall Street wasn’t entirely satisfied with the Fed’s outlook for future rate cuts.
According to Cindy Beaulieu, Chief Investment Officer at Conning, the market had adjusted rates too quickly, which caused some of the disappointment. While the initial cut exceeded expectations, Fed Chair Jerome Powell’s cautious stance on future rate cuts signaled a more measured approach.
Powell referred to the rate cut as “the beginning of this process” and emphasized the Fed’s intention to proceed carefully at future meetings. Though this strategy seems prudent, it wasn’t what all investors hoped to hear. Beaulieu added that with the economy still robust and consumers holding strong, rising long-term rates make sense.
As of Wednesday afternoon, the 10-year Treasury yield had risen 4 basis points to 3.704%, up from its yearly low. Beaulieu predicts the 10-year yield could surpass 4% by year-end, possibly reaching 4.25%, as the market navigates the possibility of a soft landing versus a potential recession.
Since the Fed’s rate hikes began in 2022, bond market volatility has been high, leading to significant losses. While inflation fears have subsided, interest rate shocks continue to cause turmoil for portfolios.
Karen Manna, fixed-income portfolio manager at Federated Hermes, noted that both the bond and equity markets tend to move ahead of economic realities. She emphasized that with so much uncertainty in the economy, predicting outcomes remains difficult.
Beaulieu remains cautious, particularly as the housing market could rebound and the Fed may struggle to reach its 2% inflation target. She also expects credit spreads to widen as the November presidential election approaches, adding further pressure on bond markets.
Manna warned that the election would keep investors on edge, prolonging uncertainty about both the Fed’s decisions and the broader rates market. She also advised investors to keep an eye on liquidity, to avoid being stuck in illiquid assets.
By the end of the day, stocks closed lower, with the Dow down 0.3%, the S&P 500 shedding 0.3%, and the Nasdaq Composite dropping 0.3%.
