Treasury Yield Curve Steepens. Bond Market a Wee Bit Nervous?
By Wolf Richter for WOLF STREET.
Treasury yields and the now un-inverted and nicely steepening Treasury yield curve passed another landmark on Friday, maybe the first such landmark ever: While the Fed cut its policy rates by a full percentage point, long-term yields have risen by a full percentage point.
Since September 16, the low point two days before the rate cut, the 5-year yield has risen by 106 basis points, the 7-year yield by 105 basis points, the 10-year yield by 100 basis points, and the average 30-year fixed mortgage rate by 100 basis points.
The 10-year Treasury yield reached 4.62% on Friday, the highest since May 1 (red), while the Effective Federal Funds Rate (EFFR), which the Fed targets with its policy rates, was 4.33% (blue). This equal move into opposite directions of the EFFR and the 10-year yield is amazing.
The yield curve steepened nicely after un-inverting entirely.
With longer-term Treasury yields rising, while short-term Treasury yields haven’t changed much during the week – no longer pricing in any rate cuts during their time window – the yield curve has steepened further, after it un-inverted entirely a week ago.
At the longer end, 5-year and 7-year yields rose by 8 basis points during the week, while 10-year and 30-year yields rose by 10 basis points, with the 30-year yield rising to 4.82%, the highest since April.
The chart below shows the yield curve of Treasury yields across the maturity spectrum, from 1 month to 30 years, on three key dates:
- Gold: July 25, 2024, before the labor market data spiraled down (which was a false alarm).
- Blue: September 16, 2024, the low point two days before the Fed’s initial cut.
- Red: Friday, December 27, 2024.
Even though the yield curve has gently steepened this week, it remains fairly flat, with only a 31-basis point spread between the 2-year yield (4.31%) and the 10-year yield (4.62%), but that spread has widened from 22 basis points a week ago.
In other words, investors are accepting still low term premiums. But when the yield curve was inverted until recently, longer-term yields were lower than short-term yields and the term premium was negative.
As the yield curve normalizes, it will steepen further and term premiums will rise. This could happen in two ways: With shorter-term yields falling or with long-term yields rising, or both.
Why the divergence of the 10-year yield from the EFFR?
Among the primary reasons the Fed cut its policy rates by 100 basis points, as it pointed out many times, were the loosening labor market conditions and the substantial cooling of inflation since mid-2022.
The labor market remains relatively solid, but it shouldn’t loosen further, the Fed said. And inflation has cooled from the highs in 2022, with all major inflation rates – CPI (2.7%), core CPI (3.3%), PCE price index (2.4%), and core PCE price index (2.8%) – well below the Fed’s policy rates and well below the EFFR (5.33% before the cuts, 4.33% currently).
With inflation rates lower than the EFFR, the “real” EFFR is positive (adjusted for inflation). Compared to November core CPI, the highest of the main inflation readings at 3.3%, the real EFFR currently is +1.0%. Since 2008, the real EFFR was mostly negative.
But the Fed didn’t cut because it saw a recession coming. Seeing a recession is the normal reason for cutting rates, but the economy has been growing at a pace that is substantially higher than the 15-year average, there is no recession in sight, and economic growth seems to have picked up in the second half, running above 3%.
The fact that the Fed has hiked rates so fast and so far, and has kept them there for so long, and that inflation has cooled so much, without the economy going into a tailspin, but cruising along at an above average pace, is historically unusual.
Faster economic growth often leads to higher longer-term yields. Conversely, recessions lead to low longer-term yields. Normally when the Fed starts cutting rates, it sees a recession, and longer-term yields are falling along with the Fed’s policy rates because the bond market too is seeing that recession.
But this time around, the Fed cut amid above-average economic growth with no recession in sight – so that’s unusual – and longer-term yields have risen amid this solid economic growth.
The bond market is getting a wee bit nervous.
Inflation concerns are now re-emerging. It has been warming up again in recent months. The Fed itself at the last meeting projected a scenario of higher inflation by the end of 2025 than now, and higher “longer-run” policy rates, and its reduced its projections for rate cuts from four to just two in 2025 for those reasons. Powell at the press conference said that the rate cut had been a “close call,” and doubts emerged during the press conference that there may even be two cuts next year.
And there are concerns that continued stimulative fiscal policies and additional tariffs will provide further fuel for inflation.
In addition, there are rising concerns in the bond market about the ballooning US debt, and about the flood of new supply of Treasury securities that the government will have to sell in order to fund the out-of-whack deficits. Treasury buyers and holders are spread far and wide, but higher yields may be necessary to reel in the mass of new buyers needed, even as the Fed is shedding its Treasury holdings through QT.
These are worrisome thoughts for potential buyers of long-term Treasury securities; they want to be compensated through higher yields for the risks of higher inflation and the risks this flood of new supply might bring.
Mortgage rates back around 7%.
Since the rate cut in September, the average 30-year fixed mortgage rate has risen by 100 basis points, from 6.11% to 7.11% on Friday, according to the daily measure from Mortgage News Daily.
The weekly measure from Freddie Mac has risen by 77 basis points over this period, to 6.85%. These higher mortgage rates despite 100 basis points in rate cuts have driven the real estate industry up the wall.
But those 6%-plus mortgages were normal in the decades before 2008, even during times of rate cuts. It’s only after 2008, when the Fed’s QE and interest-rate repression distorted everything, that these low-rate mortgages began to mess up the housing market. So maybe it’s time to get re-used to these kinds of mortgage rates that were normal before 2008.
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How high will the yield on the 10-year US Treasuries go in 2025?
The bad fundamentals, rising Inflation and rising Bond issuance by the U.S. Treasury ( given $2 Trillion deficits and Yellen/Biden issuing heavily in short term T Bills instead of locking in low interest rates) create a major problem
If history repeats itself, longer term bond yields will rise until something serious breaks in the economy or markets .
Certainly reaching 6% Ten year bond yields would do the trick.
Maybe lower.
Mr. Richter, I am an old commodity trader used to trading spreads in futures markets. What is “full carry” in a yield curve like we have in government securities? Perhaps there is a trade here – buy the 2 year note and sell the 30
Year bond at “full carry” and wait for a recession.
What do you think?
“…and wait for a recession.”
How long are you willing to wait for that recession and pay the carrying costs of the trade? People have already been waiting for that recession since July 2022.
hate to tell you but the recession has hit the bottom 70%
with their paychecks no longer making ends meet
they are digging deeper into their cc balances, routinely miss utility payments and I’ve kicked out many tenants who are living above their means
got another 2 coming end january – told them obvious
you can’t afford these nice digs – need to LIVE WITHIN your means
Bloomberg: Yellen Says Treasury to Hit New Debt Limit in Mid-January
Treasury Secretary Janet Yellen said her department is likely to begin taking special accounting maneuvers sometime in mid-January to avoid breaching the US debt limit, and urged lawmakers to take action defending the “full faith and credit” of the US.
“On Jan. 2, 2025, the new debt limit will be established at the amount of outstanding debt,” Yellen wrote in a letter on Friday to House Speaker Mike Johnson and other congressional leaders.
The Treasury will be given a short reprieve, however, because outstanding debt is scheduled to decrease by $54 billion on Jan. 2, thanks to the expected redemption of securities held by a federal trust fund.
The extra headroom is likely to be exhausted by Jan. 14 to 23, Yellen said. At that point, the Treasury will resort to special accounting maneuvers to help keep the government funded.
I smell inflation. Someone has to fund that deficit, and last I checked everyone was still voting “Not Me”.
In case you missed the memo, both teams are converging on the solution of “fuck it, we can go into as much debt as we want”… with Trump suggesting removing the debt ceiling so they won’t have an official limit on spending. Perhaps I may be missing the nuance on that idea, that maybe it’s just to avoid this same repeated drama of government shutdowns every year. Still, I don’t think you’re likely to be voting your way into the black any time soon, not without serious consequences. Either your social security check will be eliminated, or it will soon only buy you a weeks worth of groceries and that’s it.
You mean someone has to fund that national debt or it will cause inflation, but this argument has been made for over 50 years and yet, we keep on increasing the debt to infinity. Whenever it finally matters will be some sour economic times.
Mr Richter what level do treasury yields need to rise to for the current levels of the stock market to come down signifigantly? Or is it a lot more complicated than that? Too many other factors involved?
you didn’t ask me, but my opinion is that the stock market has nothing to do with treasury yields at this point. once bubble mentality exists, and people think stocks will keep going up because they keep going up, it becomes a positive feedback loop and a self-fulfilling prophecy. they’re not buying based on valuations, but on the idea that they will keep going up. therefore, it doesn’t matter whether safe yields are 0, 4, 5, or 7%. if you can get 25% or more by buying tech stocks, why none of those come close.
the stock bubble will persist until people think, on a macro level, that there is a real risk of losing their investment. as long as they think stocks are risk free, they will keep buying, no matter how stupid the valuations.
Potential home buyers need not worry too much about mortgage rates. It is so easy and inexpensive to refinance. Just follow rates lower whenever that happens.
It is always better to buy at higher rates and lower price .
Higher rates can be refinanced to lower rates if possible but you can go lower price if you have already paid higher price
Buyers are not that stupid hence the crashing sales volume
Sure, if you think rates will go back down to 2% or 3% soon. But not if you think rates will be in the new normal of 6-7% for quite some time.
Richard Grahman
But rates have been going higher. You’re engaging in reckless risk-taking with your home if you overload yourself with the mortgage because you count on refinancing at a lower rate, but then rates don’t go down, but up, and you can’t refinance and you’re stuck with the too-high price you paid, and with the too-high mortgage payment, and you’ll become a slave to that mortgage.
Go for it if you have enough cashflow for 8 plus years without needing to refinance. Everyone buying now is betting on refinancing, when it doesn’t happen, housing price might fall 30%, I’ll take out a 9% mortgage then
Loved whenever that happens. In whose lifetime do you expect rates to be lower? After a stock melt-up and a deflationary crash? Interesting times ahead
Tankster-
If those theories floating around that, in the unfolding future, BIG moves in stocks and bonds will be compressed in to shortening cycles, then maybe both the “stock melt-up” and the “deflationary crash” will transpire in hundreds of days rather than hundreds of months. The former has arguably already occurred.
The US and global institutions of money, banking and public finance are in for a severe trial. My hunch is that it will be in my lifetime….and I’m not young.
Respectfully.
Thanks for this summary of the shifting yield curve, Wolf.
Is the size and speed of the increase in treasury yields (2 years and beyond) over the past 3 months likely to lead to stresses due to portfolio markdowns (e.g. banks, mutual funds, hedge funds, private debt, collateral accounts, etc)?
Also, years ago many loans were tied to the bank’s “prime rate.” If this is still a thing, does the rise in intermediate rates pose any significant threat of a rising effective loan rate? Will this upward shift in yields crimp commercial lending by tightening cash flow projections (due to higher interest costs)?
It looks like this time is different (i.e. no recession in sight), but it’s nonetheless still interesting to notice that the last few times the “real” EFFR was positive, asset prices did meaningfully correct
Eyeballing Wolf’s chart, it looks like the EFFR was about 3% over the inflation rate the two times we had serious corrections since 2000. It would be interesting to see that chart over a longer term to see if there is a correlation there.
The bond market sees the Fed’s cuts, despite data suggesting no cuts, as absolutely inflationary. This is why there has been a big surge in long-term treasury rates. I am tempted to buy some 20-yrs, which are approaching 5%. But the spread (say 20 year minus 3 month) has to be much higher for me to jump on the 20s. The Fed is all about getting the timing right with its cuts and hikes, something this Fed has never succeeded in doing.
It’s much easier to land on an aircraft carrier when Godzilla isn’t mudwrestling right beside it.
Is it just solely fears of inflation?
If the Fed does QE then government borrowing is credit expansion, if they don’t then the government borrows from the existing money supply. I wonder if given the mass of incoming government debt, for every country really, is starting to run into the constraints of the money supply.
The current political narrative of the USA is domestic expansion but the savings rate is still as dire as ever.
After 14 years of 0% interest rates, plus trillions of dollars from the Fed,the Trump and Biden Administrations,the economy will eventually find its bearings and adjust to the new realities…
I am not holding my breath waiting for that to happen…
That chart showing mortgage rates over a fifty year timeline is a hoot…
And people are bitching about 7% interest rates!!!!
I’m still having a problem with these inflation forecasts. Every service I purchase is going up 10% or more. Went to my car dealer the other day for an oil change and decided to inquire about this $500 dealer prep charge that was added to the purchase price of the Mitzibushi Mirage I purchased there last year. The dude told me I was lucky I only paid $500. The current dealer prep charge is now $800, and is regulated by the State of Maryland to cover all the overhead in preparing the car for sale. That’s one hell of a price increase in just one year. Maybe the 10 year and 30 year bond market knows more than these shills like Yellon, Powell and pumping out on a daily basis.
LOL, you’re focused on the prep charge that went up by some peanuts, according to some yokel salesman trying to talk you into not paying it (you believe what a car salesman says???), when prices of new and used vehicles have actually fallen by thousands of dollars.
Long term yields have more room to rise with the increased incoming coupon issuance.
Down with TLT.
The change in that yield curve from July to December is just astounding! From a massively inverted ski jump to as straight and flat as a wheelchair ramp.
This statement:
“As the yield curve normalizes, it will steepen further and term premiums will rise. This could happen in two ways: With shorter-term yields falling or with long-term yields rising, or both”
..I would agree that intuitively the Govt needs to pay more interest to borrow longer. And the flat ramp means that now they are. BUT – with the timing of QT, isn’t it possible that if the deficit is reduced to say $1T next year (Growth, taxes, “efficiency”) and the Fed decides that it’s time to aggressively swap out MBS for TBills – then the Fed could buy more or less ALL of the 4 to 13 week supply (maybe $350B a year) and do it at 3.5%, which forces everyone else who would have bought those 13’s to go to the 26’s at maybe 3.6%, and onward and upwards until the ten year buyers eagerly vacuum up the supply at 4.0? Then 4.5 on the 30 and mortgages at 5.0?
Lower, flatter, better for housing and all other debtors. And if inflation is rolling along at ~3.0% the Fed can say “hey, our rate is 50bp above that, give it time”.
I’m envisioning a flat and anchored UST supply with a consistent buyer of the entire short end and everyone else taking what they can get out on the curve. After the deficit insanity of the last several years a supply of “only” $1T with 1/3 gobbled up by the Fed might seem like a scarcity. Just a thought.
Long term rates will go higher, even if the fed lowers theirs. Why would anyone tie up money for 20 years at 5 or 6 percent?
Does anyone buy and hold stocks anymore? Then why would you buy and hold fixed rate debt?
Eveeything has changed with thousands of options right from your phone. All the time it is getting faster, cheaper, and more options.
If you are waiting for rates or prices to go down before buying a home you NEED, you are playing a fool’s game.
News flash: Prices are the same, but going down due to inflation and replacement costs!
If you want a lower rate, pay a bit extra every month.
If you can’t, then you can’t afford it in the first place.
The only real reason for home prices falling is desirability. That is a very real risk for many areas.
“News flash: Prices are the same, but going down due to inflation and replacement costs!”
No, prices are going down in quite a few places, and inflation makes that decline worse. Here are some examples of prices going down, not including inflation:
Well they are not going down in CT. They have plateaued and are proving the accuracy of the adage that home prices are notoriously sticky. Cherry picking individual markets is not a good way of looking at it IMHO because there are a 1000 housing markets. I think the most one can say at the moment is that the National run up has stopped and there could even be some seasonality in that.
re: “projected a scenario of higher inflation by the end of 2025”
They must have been previously reading me.
Contrary to Nobel Prize–winning economists Milton Friedman and Anna J. Schwartz’s “ A Monetary History of the United States, 1867–1960 “ monetary lags are not “long and variable”. No, the distributed lag effects for both real output and inflation have been mathematical constants for over 100 years
The 2-year rate-of-change in money flows, the volume and velocity of means-of-payment money, the proxy for inflation, rises in 2025 (after bottoming in August).
The odds are the 10 year is going higher. Debt is 36 trillion, the deficit is around 2 trillion or around 6% of GDP, and Trump and the Republicans are promising to extend his 2017 tax cuts and introduce more as well as some expensive spending programs. Little faith can be placed in the promises of 2 billion of spending cuts because of the content of the Federal budget and every program has it interest group including a lot of Republican politicians whatever they say so this means even higher deficits (3 trillion?). What is going to bring all this to a close is the markets which is what happened at the start of the 90’s.
watch the almost daily treasury auctions. 500 billion a month and rising.
somebody has to buy those bills & bonds. And as rates rise, more to sell.
Most of those auctions just refinance maturing securities. Nearly all of these huge T-bill auctions refinance maturing T-bills. For example, 1-month T-bills mature in one month and are then refinanced (rolled over). These roll-overs are NOT new supply, and they do not require new demand. These roll-overs would continue even if the debt suddenly stops rising because Congress suddenly passed a balance budget, LOL.
What you need to watch is NEW supply. New supply has been running at about $160 billion a month.
Does that include the rollovers of treasuries and MBS securities owned by the Fed but rolling off with QT?
I would argue that those QT roll-offs are as important as new treasury issuances in this.
Re: mkt getting a wee bit nervous
The most dependable thing about mkts, is for expectations to be incorrect. Mkts always inflect max pain when people don’t expect declines.
Between the deficit, treasury issuance, money supply, inflation and the entire spectrum of pandemic low to now, everything seems broken, and confusing, making a logical directional bet here is virtually impossible — and there’s definitely a disproportionate amount of unease — and a wee bit of nervousness.
As the roulette wheel spins wildly, it’s a safe bet to think that most people will get things wrong — which helps amplify volatility and our perpetual state of being nervous.
I’d be remiss to not plug the Buffett Indicator, or go off topic with his hamburger thesis:
“ “To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the ‘Hallelujah Chorus’ in the Buffett household. When hamburgers go up in price, we weep. For most people, it’s the same with everything in life they will be buying — – except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”
I feel strongly that we’re at an inflection point that plays out within weeks — but, the nature of this pandemic everything bubble — offset by the super resilient optimism has been extremely puzzling — extremely disconnected from prior realities, which makes virtually any investment bet unpredictable.
For that clarifying reason, the reason for markets to be uncertain is uncertainty. That’s the key ahead, I think — there will less conviction and greater hesitancy, and volatility will rip people apart in a whipsaw blender of stupidity — which ultimately is exactly what needs to happen.
Afterwards, sometime in the future, the price of hamburgers will be attractive Again.
Well, beef is not the most affordable option anyway and government subsidized. Perhaps we need more subsidies to decrease the price of the hamburger. Eat the offspring of the dinosaurs instead.
I believe that we are getting closer to something breaking very hard that just might burn some bond shorts. The major currencies have been getting crushed. The Rupee , Won, Real, Yen, Canadian dollar Euro to name a few. Chinese interest rates at all time lows. Europe a complete mess. Everyone worried about tariffs being inflationary but not talking about how contractionary they are. You’re starting to see the cyclical stocks and some of the semis in downtrends. I think one nice spike in rates will kill the stocks and turn bonds around for a good rally.
Rising rates have lead to major cracks in the market before. 4.62% risk-free on the 10-year (and climbing) vs an overvalued stock market sounds pretty compelling.