Despite expectations of a rate cut, Treasury yields are actually rising

Tue Mar 26 2024
Jim Andrews (505 articles)
Despite expectations of a rate cut, Treasury yields are actually rising

Continued interest rate reductions are a goal of the Federal Reserve. The yield on Treasuries, which affects the cost of borrowing money and influences mortgage rates, is going up nevertheless.

From 3.860% at year’s end to 4.252% as of Monday, the yield on the benchmark 10-year U.S. Treasury note increased, according to Tradeweb. Borrowing costs in the corporate bond market and the average rate on 30-year fixed mortgages have both gone up as a consequence.

Wall Street had anticipated a decline in yields, so the increase has come as a surprise to many, and the American people, who have been waiting for mortgage rates to drop from their 20-year highs, are understandably irritated. However, it highlights the intricacies of the U.S. borrowing cost determination process and the ongoing ambiguity around their potential trajectory.

Find out what’s influencing Treasury yields and why they could rise or fall soon by reading this.

To a considerable extent, investors’ expectations for the long-term average of the Federal Reserve’s benchmark short-term rate determine the yield on Treasurys, which increase when bond prices decline. Mortgage and other fixed-rate debt rates were subsequently floored by them.

The Federal Reserve’s short-term interest rate is currently at a 23-year high, ranging between 5.25 to 5.25 percent. Investors anticipated six rate cuts this year, bringing the Fed’s benchmark interest rate down to 3.75%—4%, as we entered 2024.

A sobering dose of reality followed. Investors have reduced their wagers on rate cuts because to stronger-than-expected inflation data for January and February and sustained economic growth. The market now projects rates to close the year somewhere between 4.25 and 4.5 percent.

Even the central bank is hinting at possible reductions. Last week, a poll of Fed officials revealed that, consistent with their December prediction, their median outlook for this year is three reductions. Treasury yields, on the other hand, have risen as market expectations have converged with the Federal Reserve’s forecasts.

To what extent are higher Treasury yields still possible? During his State of the Union speech earlier this month, President Biden mentioned that if inflation keeps falling, mortgage rates will decrease, and he added, “the Fed acknowledges that.”

In actuality, things are more convoluted. Treasury yields may still go up, even if the Federal Reserve doesn’t lower rates this year. Just keep reducing your wagers on the amount you think the Fed will reduce in 2024 and beyond, and investors will do just fine.

Doing that shouldn’t be that challenging. Interest rate wagers that the Federal Reserve’s benchmark rate will decline by about 2% in the coming years are still reflected in the current yields.

According to Jeffrey Cleveland, chief economist at asset manager Payden & Rygel, “Cuts will come, but it’s going to be later and there are going to be fewer cuts this year.” Therefore, it’s reasonable to expect slightly higher 10-year yields.

A level of interest rates that would have no effect on economic growth is the Fed’s end aim. What exactly that so-called neutral rate is, though, is a matter of great uncertainty.

The median expectation for where officials believe rates would settle in the “longer run” was 2.6% according to last week’s interest-rate projections. For the first time since the middle of 2019, the forecast was somewhat higher than 2.5%, and according to some experts, it will likely continue to float higher in the coming surveys.

Naturally, the Fed has the option to reduce rates to levels below 2.5%, which were seen before the pandemic. However, Cleveland stated that this is highly improbable within the next six months, so investors are left to consider several possibilities, such as a scenario where the Federal Reserve hardly lowers rates in the years to come.

Why do a lot of people think yields will go down?

Treasuries’ yields have not recovered to their October highs, when the 10-year yield hit a 16-year high of about 5% for a short period of time. The economy was showing signs of speeding up at the time, and investors were still worried the Fed would keep hiking interest rates.

Returning to 5% is a challenging goal, according to many investors.

According to John Madziyire, head of Treasurys at Vanguard, this would have to happen either when there are indications of a substantial acceleration in economic development or when there are growing worries about the issue of Treasurys that are necessary to pay the federal budget deficit.

He predicted that a 10-year yield of about 4.5% was more realistic. On the other hand, Madziyire predicted that, barring a recession that would necessitate drastic rate cuts, the yield may fall to as low as 3.5 percent if inflation continues its downward trend.

For this reason, Madziyire stated that his group is prepared to purchase further Treasurys as soon as the 10-year yield reaches its recent high of approximately 4.35%.

Plus, there’s a limit to how much Treasurys can be sold off until you factor in rate hikes, even if the Fed doesn’t lower rates, he said.

Jim Andrews

Jim Andrews

Jim Andrews is Desk Correspondent for Global Stock, Currencies, Commodities & Bonds Market . He has been reporting about Global Markets for last 5+ years. He is based in New York