The expected rate cut gets complicated: A dovish Fed amid rising inflation can spook the bond market.
By Wolf Richter for WOLF STREET.
The Treasury market – and the mortgage market with it – has gotten a little ruffled since the tranquility of Thanksgiving week ended, despite the widespread assumption that the Fed will deliver another rate cut this week.
The 30-year Treasury yield has risen by 17 basis points since the day before Thanksgiving, including 2 basis points today, to 4.81%, the highest since September 4. Since the rate cut in October, the 30-year yield has risen by 26 basis points. Since the first rate cut in September last year, it has risen by 87 basis points.
The Effective Federal Funds Rate (EFFR, dotted blue line in the chart), an unsecured overnight rate at which banks lend to each other, and which the Fed targets with its monetary policy rates, has been drifting up ever so slightly after each rate cut, starting in September, amid tighter liquidity in the money markets, including bouts of turmoil in the repo market. And the 30-year Treasury yield is just ignoring the EFFR.
The 10-year Treasury yield briefly jumped nearly 6 basis points this morning to 4.195%, just a hair from 4.20%, but then edged back and closed at 4.17%, up by 3 basis points from Friday, and up by 17 basis points from the day before Thanksgiving, and the highest close since November 5 (also 4.17%), and both had been the highest since October 6.
Since the October rate cut, the 10-year Treasury yield has risen by 18 basis points. Since the first rate cut in September 2024, it has risen by 54 basis points.
The Fed’s short-term policy rates and hopes for rate cuts have only limited impact on the long end of the bond market, where yields are largely driven by fears of future inflation and fears of an onslaught of new supply of Treasuries that the market has to absorb by pulling in more investors, potentially with more attractive, thereby higher, yields — meaning lower prices for existing bondholders.
The inflation scenario is made worse if the market sees prospects of a lax Fed in face of inflation.
The Fed, at its interest-rate decision on Wednesday, will have to make do without much of the current data that is still tangled up in the after-effects of the government shutdown, including inflation and labor market data.
Markets now expect a “hawkish cut,” with several dissents and a hawkish tone of the “dot plot” depicting participants’ projections for rates, inflation, unemployment, and economic growth. The Fed may also provide more details on its balance sheet.
In addition, the market has to digest six Treasury bill auctions this week, two Treasury note auctions (3-year and 10-year Treasury notes) and the 30-year Treasury bond auction.
Today was already busy with three auctions, totaling $228 billion, including $90 billion of 3-month T-bills and $80 billion of 6-month T-bills, both pricing in a rate cut this week.
At the 3-year auction this morning, $58 billion of Treasury notes were sold at a yield of 3.614%. In the secondary market, the 3-year yields rose to 3.62%, the highest since November 5.
Mortgage rates got pushed up by rising long-term Treasury yields. The daily measure of the average 30-year fixed mortgage rate by Mortgage News Daily jumped by 9 basis points today, to 6.36%, the highest since November 20.
The average life of a 30-year mortgage is less than 10 years as mortgages get paid off prematurely via refis and sales of mortgaged homes. And so the mortgage market roughly tracks the 10-year Treasury yield, with mortgage rates being somewhat higher, and this spread varies over time.
Before the first rate cut in September 2024, the average 30-year mortgage rate had dropped to 6.11%. Rate cuts by the Fed do not mechanically translate into lower 30-year fixed mortgage rates. Mortgage rates are a function of the bond market.
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The long bond market is starting to price in Trump’s replacement for Powell. This will be somebody who will kiss Trump’s heinie, and lower short term rates as quickly as possible, thus spurring inflation. I would be very nervous if I was buying long-term Treasuries (10, 20, 30 years).
If you go to the dictionary and look up the word sycophant
an ever smiling Kevin Hassett looks back at you.
Who would one buy a 3 yr at 3.6?
Reminds me of those buying ten yrs at .5%
Every signal from free market action says the Fed should NOT cut.
Long end is wobbly and the SOFR in which there is a scrambling for money over 4% all say rates are NOT restrictive but attractive.
Add in stocks all time highs, prices all time highs for metals and cost of living. Inflation over the “target” for 4 years.
If you cut now, when do you raise rates?
What’s also interesting is that Trump’s economic approval among the people is in the toilet. Goes to show that for Trump as with Biden, the American people, as a whole, don’t care about stock prices.
But if you let the financial media dictate your view, you’d think that’s all that mattered.
The 10 year bond should be at 10-20 percent. This would cause a recession, but then inflation would stop and prices might decline. Great, but jobs for poor college kids and the rest of us would be scarce and even scarcer because of AI. So which way does the FED go? I think for jobs. The hell with inflation, buy gold and silver and stay out of bonds.
I figure if the 30yr hits 6% I can load up the truck and retire a few years earlier. Hopefully that’s not a dumb decision….
Nice to see that long-term yields and mortgage rates are rising just as expected they would.
MW: Mortgage rates are surging ahead of the Fed’s expected rate cut. What gives?