The bond market’s reaction to the inflationary environment, to fears of a lax Fed, and to a Mississippi River of new debt.

By Wolf Richter for WOLF STREET.

The 30-year Treasury yield rose by 10 basis points on Friday to 4.96%, despite a 30-year Treasury auction on Thursday that was described as “solid” and “strong,” where the government sold $22 billion of 30-year bonds at a yield of 4.89%.

So far in July, the 30-year yield has risen by 18 basis points. It is now 63 basis points above the effective federal funds rate (EFFR), which the Fed targets with its monetary policy rates (blue in the chart).

This increase in yield came despite the government’s assurances that it would only slowly replenish its checking account, the Treasury General Account – which had been partially drained during the debt-ceiling period – by taking it easy on issuance of long-term notes and bonds, and by slowly increasing the issuance of short-term T-bills, all in order to defuse the pressures around long-term yields, while short-term yields are bookended by the Fed’s policy rates and expectations of those policy rates over the near term.

So, since the Fed cut by 100 basis points starting in September (dotted blue line), the 30-year yield (red line) has risen by 102 basis points!

The 30-year yield is a thermometer of the bond market’s current fears about:

• Inflation over the long term
• A lackadaisical Fed in face of this inflation
• And a Mississippi River of new Treasury debt flowing into the market.

That the 30-year yield is back near 5% amid all these efforts to keep it from going there is quite something.

This reaction – rate cuts of 100 basis points lead to a 102-basis-point increase of the 30-year yield – raises the secret question: How many more rate cuts would it take to drive the 30-year yield to 6%?

Cutting policy rates in an inflationary environment has turned out to be a very tricky thing. Bessent may have had this type of conversation with Trump, but it likely went in one ear and out the other.

The yield curve: bond anxiety.

The chart below shows the yield curve of Treasury yields across the maturity spectrum, from 1 month to 30 years, on three key dates:

• Red: Friday, July 11, 2025.
• Gold: January 10, 2025, just before the Fed officially pivoted to wait-and-see.
• Blue: September 16, 2024, just before the Fed’s rate cuts started.

With rate cuts still on ice, short-term yields up to six months haven’t budged much and remain glued to the EFFR of 4.33%. But rate-cut expectations have pushed down yields over six months and into the five-year range.

What is pushing up long-term yields are the other factors: inflation expectations over the long-term, concerns over a lackadaisical Fed in face of this inflation, and a Mississippi River of supply flowing into the market that has to be absorbed by additional buyers that may have to be enticed with higher yields.

So, at the long end, the yield curve has steepened. The 10-year yield is higher than all yields shorter than 10 years:

• Between 8-16 basis points higher than 1-6-month yields
• About 52 basis points higher than the 2-year yield
• About 56 basis points higher than the 3-year yield

And the 30-year yield is right back where it had been on January 10, just a hair below 5%.

The 10-year Treasury yield has been hovering near the EFFR for months. But it too has risen: by 8 basis points on Friday, by 19 basis points so far in July, and by 80 basis points since the eve of the Fed’s rate cuts.

The six-month yield, which is a good indication of market expectations for cuts within 2-3 months, has been glued to the underside of the EFFR and is thereby not yet predicting rate cuts within 2 to 3 months.

The FOMC’s September meeting, with a rate decision to be announced on September 17, is just on or beyond the outer edge of the 6-month yield’s vision. So going forward, we’ll watch the 6-month yield for indications of a September rate cut.

But there is now substantial disagreement among the FOMC members about rate cuts. The CPI report next week may shift their rate cut rhetoric into one or the other direction, and the 6-month yield would then begin to react to it.

For 30-year fixed mortgage rates, the 10-year yield and the spread matter.

The average 30-year fixed mortgage rate has been above 6% since September 2022 and has stuck fairly closely to either side of 7%.

In the latest reporting week, which does not yet include the rise of the Treasury yields over the past few days, the average 30-year fixed mortgage rate ticked up to 6.72%.

It didn’t drop to 5% until the Fed started QE, including buying trillions of dollars of MBS, from early 2009 on, which helped push down mortgage rates. But the consumer price inflation that broke out in 2021 put an end to it.

The spread between the average 30-year fixed mortgage rate and the 10-year yield has been fairly wide since the Fed ended QE and thereby stopped buying MBS, and then started QT in the second half of 2022, thereby starting to unload its MBS. It has by now unloaded over $600 billion of its MBS, and has said many times that it wants to get rid of its MBS entirely, and only hold Treasury securities on its balance sheet.

The spread between the weekly average 30-year mortgage rate and the weekly average 10-year Treasury yield was 2.34 percentage points. Over the past four decades, that happened only four times, twice very briefly just before and at the end of the Dotcom Bust, and twice during two panics, when the 10-year yield plunged amid massive QE, and mortgage rates were slower to follow. Now there is no panic, the 10-year yield is near 4.5%, and the Fed is doing QT..

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