Recent strong labor market data and rising consumer inflation expectations have only fueled these worries, resulting in stock sell-offs and a bond market rout.
Since the early 1980s, there have been only two instances where the 10-year Treasury yield surged nearly as much as the Federal Reserve slashed interest rates. This rare phenomenon is primarily tied to rising inflation expectations and is now shaking stock market confidence.
The benchmark 10-year Treasury yield, a key rate influencing borrowing costs for mortgages, corporate bonds, and auto loans, has risen sharply—climbing to 4.77% from 3.6% since mid-September.
This increase coincides with the Fed’s recent series of rate cuts totaling a full percentage point over three months, marking a unique divergence from historical patterns. Traditionally, long-term yields fall during periods of monetary easing, facilitating lower borrowing costs.
Torsten Slok, chief economist at Apollo Global Management, highlighted the significance of this anomaly, suggesting it reflects growing concerns about U.S. fiscal policy, diminishing foreign demand for Treasury debt, or skepticism over the Fed’s justification for its 2024 rate cuts.
Notably, inflation is emerging as a primary driver behind these bond market movements. Portfolio managers such as Brian Mulberry and Guy Haselmann caution that the Fed’s battle with inflation is far from over.
The three-month annualized core inflation rates have hovered near 3%, suggesting inflationary pressures persist. Mulberry believes this signals the end of the Fed’s easing cycle, with interest rates likely remaining elevated around 4%.
The current scenario mirrors a similar episode from 1981 when, under Fed Chair Paul Volcker, interest rates were cut to combat recession but long-term Treasury yields spiked due to surging inflation expectations. Haselmann argues that the market’s focus on inflation expectations, rather than fiscal deficits, explains the current yield surge.
Looking ahead, elevated interest rates are expected to heighten stock market volatility, with growth-oriented sectors and smaller companies facing the greatest pressure. Meanwhile, utilities and safer investments may offer relative stability.
As the 10-year yield approaches 5% and the 30-year yield tests 6%, a wave of buying interest could emerge, though caution remains essential.
This environment underscores the challenges the Fed faces in balancing inflation control with economic stability. Whether rates stabilize, rise, or fall will depend heavily on incoming data, including key inflation updates and market responses to evolving conditions.
