The bond market’s reaction to cocktail of inflation fears, potentially lax Fed, and Mississippi River of new debt flowing into the market.
By Wolf Richter for WOLF STREET.
The 30-year Treasury yield rose 5 basis points on Friday and closed at 4.93%. Since the beginning of March, it has risen by roughly 50 basis points, as the bond market reacted nervously to Trump’s enormous pressure on the Fed to cut interest rates amid worsening inflation, driven by inflation in services.
The 30-year Treasury yield is now 60 basis points above the effective federal funds rate (EFFR), which the Fed targets with its monetary policy rates (blue in the chart).
When the Fed cut its policy rates by 100 basis points in 2024 amid rising inflation, the 30-year Treasury yield, in a massive counter-reaction, rose by 100 basis points, and we began musing here about a secret question: How many more rate cuts would it take to drive the 30-year yield to 6%?
Inflation kills the purchasing power of bonds, and investors want to be compensated for the expected loss of purchasing power by being paid a higher yield. So the bond market wants to be reassured by a hawkish Fed that inflation will not be allowed to run wild.
But Trumps efforts of installing a lackadaisical or even reckless Fed even as inflation is accelerating and far above the Fed’s target is making the bond market very nervous – and the 30-year yield shows that.
In addition, investors have to absorb the Mississippi River of new Treasury debt flowing into the bond market – meaning new investors need to be enticed into the market, and that happens with more attractive and therefore higher yields.
The 10-year Treasury yield has been glued to the EFFR for months, sometimes a little higher, sometimes a little lower.
On Friday, it ticked up two basis points to 4.23%, which is exactly where it was a month ago, and exactly at the end of February, and exactly two years ago at the end of August 2023. It’s up about 80 basis points from just before the Fed cut its policy rates in September last year.
But the six-month Treasury yield dropped further on Friday, to 3.98%, the first time below 4% since October 2022 when the Fed was still hiking rates in large increments.
It is now pricing in nearly two rate cuts in its window of about 2-3 months, so one cut at the September 17 meeting, and it’s getting closer to pricing in a cut at the October meeting.
The Fed is under enormous pressure to cut. Before the FOMC’s September 17 meeting, there will be a number of data releases, including crucially, one more nonfarm jobs report and one more CPI report.
But the Fed is under such enormous pressure from Trump that it will likely cut by 25 basis points, even if the jobs report turns out to be rock-solid and CPI comes out red-hot.
There may be dissents by FOMC voters, maybe in both directions, for a bigger cut and for no cut, and the majority voting for the 25-basis-point cut may be slim. But the Fed is under such pressure that a 25-basis point cut will give it some breathing room.
If inflation accelerates further in the fall, while the labor market is solid, Fed officials will have more ammo to defend not cutting again this year.
The yield curve steepened a lot at the long end. 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, August 29, 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.
The 1-month yield is boxed in by the Fed’s five policy rates (from 4.25% to 4.50%) and closely tracks the EFFR. So the 1-month yield hasn’t changed much since the last rate cut in December.
But rate-cut expectations have pushed down the shorter end of the yield curve, while fears of inflation, fears of a lax Fed, and fears of the Mississippi River of new Treasury issuance have tied the 30-year yield close to the 5% mark.
With the 2-year yield falling to 3.62%, and the 30-year yield at 4.93%, the spread between them has widened to 131 basis points on Friday, the widest since November 2021. That part of the yield curve, from the 2-year yield to the 30-year yield has steepened a lot this year.
Mortgage rates track the 10-year yield, and the 10-year yield is stuck. The average 30-year fixed mortgage rate in the most recent reporting week (from Thursday last week through Wednesday this week) edged down to 6.56%, according to Freddie Mac data on Thursday. It has been above 6% since September 2022.
On the eve of the rate cuts last September, this measure of mortgage rates had dropped to 6.09%. But then the bond market freaked out over a lax Fed amid rising inflation.
Further rate cuts, if inflation continues to accelerate, may not be good for mortgage rates.
Mortgage rates didn’t drop to 5% until the Fed started QE, including buying trillions of dollars of MBS, from early 2009 on, which was designed to push down mortgage rates.
Under the force of the Fed’s mega-QE of 2020-2021, mortgage rates dropped below 3%, even as consumer price inflation broke out in late 2020 and then spiked in 2021, creating the most negative “real” mortgage rates (mortgage rates minus CPI) ever. And money was suddenly free.
And when money is free, price no longer matters, and home prices exploded far beyond where they make economic sense when money is not free.
With these policies, the Fed broke the entire housing market. The housing market has now been frozen for three years. These too-high prices have started coming down in many markets, faster for condos than for single-family homes, but it’s a slow process. It’s unlikely the Fed will do that ever again.
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The seller will eventually crack as the cash buyer wins through patience/attrition .
Have a fantastic weekend W.R. and posters ! 🍻
Most of us are not cash buyers! Its pushed first time home buyers out of the market.
The whole thing is insane , could be fixed thru less greed, common sense and stop trying you predict and just let things fall into place naturally. A rate between 4 and 5.50 seems doable for most folks. 6 or higher is just greed.
A 30-50% price decline in home prices will make homes affordable again. Yes, less greed = lower prices. Lower rates = more greed and higher prices.
President Trump will lower interest rates and the economy will take off like a rocket.
If that happens, long term yields will take off and shut down the housing market and long-term financing (corporate bonds, etc.).
The article explains that principle, and how it played out in 2024 when the Fed cut 100 basis points upon which long-term yields jumped 100 basis points.
The president can remove the Fed chairman, but only for cause, such as misconduct or neglect of duty, not simply for policy disagreements. This process is governed by the Federal Reserve Act, which aims to protect the Fed’s independence.
What the heck? Why is the Fed under such “pressure” from Trump, when Trump or any president for that matter, can’t remove the Fed Chair simply for policy disagreements, which is what’s going on with Trump and his rate cut demands.
Powell ought to raise his middle finger to Trump and leave it at that.
Another superbly detailed exposition of one of my favorite topics that Wolf regularly covers, and I’ll admit that I’m one of the readers here who’s been fantasizing about loading up on 6% long-term treasuries if the opportunity arises. But now I’m going to show my naïveté of the broader topic with this question…
I can see the Fed succumbing to pressure to lower short-term yields and simply declaring one (or more) rate cuts, and how this can subsequently bring out a new generation of bond vigilantes demanding higher long-term yields that would further steepen the yield curve. However, looking ahead toward how the “powers that be” might also try to additionally push down the long-term treasury yields, can they not simply shift even more of the upcoming federal debt into short-term treasury issues in order to keep the long-term treasury supply at a minimum, and simultaneously push for the Fed to again restart the QE machine with the Fed purchasing long-term treasuries? Is it possible that this is someone’s planned thinking for ultimately controlling interest rates across the board over the next few years?
Bond market participants are not stupid, they are not going blindly continue to buy and hold treasuries at top dollar in a long term inflationary environment no matter how many QE programs the fed tries to shove down their throat.
Seeking Cassandra,
Shifting the number of long-dated bonds to short-term bills will certainly reduce pressure on long term rates. Despite the reduced number of long term issues, those most interested in long dated bonds such as insurance companies are going to require higher yields based upon their perception of monetary and fiscal policies. Otherwise they are buying an asset they expect to lose money on. Restarting QE would set rates on fire. Markets are a psychological phenomenon more than anything else, at least until fundamentals re-assert themselves.
Enjoy your Labor Day Weekend!
“How many more rate cuts would it take to drive the 30-year yield to 6%?” Actually, I wouldn’t pose that musingly afterall.
These interest rates are ridiculously low. The 30 year should be at 10%. Mortgage rates should be at least 12%. The US is now the Titanic in the North Atlantic. The question is not whether it’s going to hit an iceberg, it’s when. It’s inevitable.
Yeah, but with Fannie Mae and Freddie Mac backing all those MBS with tax payer dollars, it keeps the rate artificially low.
Wolf, the chart showing change in yield curve between Sep 16, Jan 10 and Aug 29 is elegant in its simplicity, but conveys a lot of visual information. Nice work.
I ask these tongue in cheek, but are those the Bond Vigilantes holding up the long end of the curve? And what name will the captured Trump FOMC use for YCC when the time comes? They can’t call it yield curve control, so they’ll obfuscate with jargon as they do.
These are great charts. A picture is worth a thousand words. The greatest risk to the economy is an explosion in the 30 year bond rate. The Fed does not control this rate. If it goes any higher say to 5.5% then you can kiss the real estate market goodby. Any move by the Fed to lower rates on the short end could trigger this rise in long term rates. Trump will then own the resulting recession. He’s walking into a trap by harping on the Fed to lower rates. The economy is overheated right now and doesn’t need a cut in rates. I was out and about town today here in the Swamp and observed massive traffic jams, stores with lines at the cash registers and full of drunken sailors spending like there was no tomorrow.
I was just helping a realtor friend today that wanted to lower their lease payment. I think they are struggling. They said “when the Fed lowers the rate then buyers will come out again and prices will go up”. In order not to lose the sale I just laughed in my head, not out loud.