(Yahoo! Finance) - Investors clamoring for the Federal Reserve to come off the sidelines and cut interest rates in September might want to pay close attention to the bond market.
The $28 trillion Treasury market’s yield curve has been steepening on expectations that Fed Chair Jerome Powell could use his annual speech at the central bank’s Jackson Hole, Wyo., summer economic symposium on Friday to keep the door open for further rate cuts.
The policy-sensitive 2-year Treasury yield BX:TMUBMUSD02Y has dropped sharply to 3.8% from around 4.4% since the Fed last lowered rates in December, reflecting growing confidence around the rate-cutting cycle resuming.
But in a more worrying sign, the benchmark 10-year Treasury yield BX:TMUBMUSD10Y, which does heavy lifting in terms of financing households, companies and the U.S. government, has remained little changed from eight months ago at around 4.3%.
Furthermore, the 10-year rate a year ago was notably lower at 3.8%, before the Fed reduced its policy rate for the first time in four years.
The White House has been staging a high-profile campaign to suggest the Fed should have lowered rates already this year. President Donald Trump publicly talked of the idea of firing Powell and has frequently criticized the U.S. government’s high debt-servicing costs.
Yet as Trump urges Powell to cut rates and tells companies to “eat” the cost of his administration’s tariffs, the central bank has stuck with its wait-and-see approach on lowering rates, not wanting to see inflation return with a vengeance.
Investors now expect inflation in a year from now to be at 3.3%, well above the Fed’s 2% annual target, according to Torsten Slok, chief economist at Apollo Global Management.
“If the market thinks the Fed is cutting for political reasons, it puts upward
pressure on inflation expectations and ultimately long rates, which also
steepens the curve,” said Slok, as well as Apollo’s Rajvi Shah and Shruti Galwankar, in a Tuesday client note.
Watch the 10-year
Beyond inflation concerns, Trump’s signature budget law is expected to grow the U.S. deficit by $4.1 trillion over the next decade and require more Treasury issuance to help pay for its tax cuts and spending plans.
That’s one explanation for why there’s been upward pressure on longer-term 10-year and 30-year BX:TMUBMUSD30Y Treasury yields this year.
While the Treasury has been leaning heavily on short-term T-bill issuance, the U.S. government has been paying $1 trillion annually in debt-servicing costs, according to Apollo.
Yet larger Treasury auction sizes and growing fiscal concerns appear to be driving up the “term premium” in the bond market, or the extra yield investors demand on longer-term Treasurys, according to the Apollo team.
That spread between the 2-year Treasury rate and its 10-year counterpart was 57 basis points to start the week, up from 25 basis points since the Fed’s last rate cut of 2024, according to the St. Louis Fed.
“Reasonable” arguments have been made about how U.S. deficits help explain the rising term premium, said Ryan Swift, U.S. bond chief strategist at BCA Research, on Tuesday.
“My best guess,” Swift said, is that sweeping tariffs imposed this year also have been playing a role — with Trump looking to rebalance the global trade order in ways that likely mean “less global trade in general.”
While Swift said there’s no guarantee the White House’s trade policy will be a successful endeavor, he thinks that “in the long run, just the risk that it might happen is enough to build this risk premium” into bonds.
So, what could trigger lower long-term bonds yields? A significantly weaker labor market, according to Swift.
“It’s 100% contingent on the unemployment rate rising,” he said.
