From September 17, 2024, the day before the Federal Open Market Committee (FOMC) commenced its current round of short-term interest rate cuts, through November 15, 2024, the yield on 10-year Treasuries jumped by 79 basis points, from 3.65% to 4.44%. It is not unusual for the 10-year Treasury yield to move in the opposite direction of the committee’s change in the Fed funds rate. That has happened 40% of the time, measured on a month-over-month basis, in the period from 1989 to the present. Still, a rise of 79 basis points in just two months is noteworthy. To put that number in perspective, the median amount by which the 10-year Treasury yield rose or fell in a year over the period 1962-2023 was just a bit greater, at 85 basis points.
The magnitude of the recent rise in the benchmark 10-year Treasury yield invites us to ask what triggered it. Financial theory holds that a strengthening economy boosts the demand for debt capital, pushing up its cost, i.e., the interest rate charged by suppliers of the capital. At the same time, the debt capital’s suppliers demand a premium on the market-determined real interest rate to offset the expected future inflation-induced loss of purchasing power. An increase in the expected inflation rate raises the overall cost of debt capital, so the recent increase in the 10-year Treasury rate might reflect fears that inflation will escalate.
On November 12, 2024 the Wall Street Journal flatly stated, “The yield climb in recent weeks reflects heightened concerns about inflation, which some economists say could worsen under a Trump administration.”[1] Taking a diametrically opposed position, Federal Reserve Chair Jerome Powell said in his press conference following the Fed’s latest quarter-point rate cut on November 7, 2024:
[I]t appears that the moves are not principally about higher inflation expectations, they're really about a sense of more likelihood of stronger growth and perhaps less in the way of downside risks.
Who is right, the nation’s largest-circulation daily newspaper or the person with the biggest say in determining US monetary policy?
An absolutely conclusive answer to that question would require eliciting answers—and honest ones at that—from all recent buyers and sellers of ten-year Treasury bond about their reasons for transacting. Such an undertaking is infeasible, but we can make inferences from certain indicators of market expectations regarding inflation and economic growth. The next two sections of this report pursue approaches to gauging the relevant expectations.
Economists’ Forecasts
One means of ascertaining expectations is to survey economists. Bloomberg casts its net widely, most recently compiling 69 forecasts of the 2025 year-over-year change in the Consumer Price Index. The September survey came in at a median of 2.2%. That rose to 2.3% in the October survey.
In contrast, the 77 economists who weighed in on the 2025 gain in GDP produced a median forecast of +1.8% in both the September and the October surveys. Accordingly, this round goes in favor of the Wall Street Journal’s opinion that rising inflation expectations account for the 10-year Treasury yield’s increase.
Market-Based Inflation Forecast
A second way to assess expectations for inflation involves the breakeven rate on Treasury Inflation-Protected Securities (TIPS). The yield difference between these instruments and ordinary Treasury bonds represents the amount of purchasing power that investors in aggregate believe they will need to offset through an inflation premium. According to YCharts, the ten-year TIPS breakeven rate stood at 2.12% on September 17, the day before the Fed began easing. By Election Day (November 5), it had risen to 2.27%. The TIPS breakeven rate climbed further to 2.33% on November 15. No comparable measurement mechanism is available for GDP, but the rise in the TIPS breakeven rate supports the Wall Street Journal’s view that inflationary concerns sparked the past two months’ escalation in Treasury yields.
Graph 1: 5-year US TIPS Breakeven Rate ("Implied Inflation Rate")
Source: Bloomberg Professional Services
Implications of the Equity Rally
While the evidence presented so far has favored the inflation-expectations explanation of the rise in bond yields, proponents of the accelerated-economic-growth explanation can cite in their favor a strong rally in stock prices. Between September 17 and November 15, the Standard & Poor’s 500 Index rose by 4.19%. That two-month gain compares with a median quarterly gain of 2.9% over the period 1Q1997 to 3Q2024, confirming that the period from initial Fed easing has been a strong one for the stock market.
Graph 2: S&P 500 Index (Blue Shaded Area) vs. 10-year US Treasury Bond Yield (White Line)
Source: Bloomberg Professional Services
Rising equity prices are commonly interpreted as expressing a consensus view that economic growth will accelerate. The case is not as simple as that, however. For one thing, financial theory tells us that a reduction in the discount rate applied to future dividends will boost stock prices in and of itself, regardless of whether expectations for economic growth (and hence dividend hikes) increase. The Fed has delivered that reduction in the discount rate through its two recent cuts in the Fed funds rate.
There is no direct way of telling which driver, higher economic growth expectations or a lower discount rate, has done the most to propel the S&P 500 to a higher level over the past two months. The historical record lends some support, however, to an argument that escalated GDP growth expectations likely played the bigger role. For the period 1963-2024 we ran correlations of the year-over-year percentage increase in the S&P 500 with (a) the subsequent-year change in GDP growth and (b) the same-year change in the Fed funds rate. (The subsequent-year GDP growth change was our expectations proxy, with the obvious imperfection that unforeseeable events in any given year can render prevailing expectations null and void.)
The S&P 500’s correlation with the subsequent change in GDP growth was just 18.78%, at the high end of what is considered a very weak correlation. It was nevertheless nearly twice as high as the stock index’s 9.71% correlation with the change in the Fed funds rate. Score at least a small point in favor of Powell’s contention that bond yields rose because investors reacted as they tend to do when they think economic growth is about to accelerate.
Conclusion
Interpreting financial market behavior is not a cut-and-dried process in which everything can be explained to everybody’s satisfaction with a few simple formulas. If that were so, we would not observe pundits in the media not only presenting conflicting forecasts of future securities prices, but even offering divergent explanations of past market events. Such is the case with the opposite views of the Wall Street Journal and Jerome Powell on the cause of the past two months’ sharp rise in Treasury bond yields. Unsurprisingly, our analysis has not produced a smoking gun by which investors can, with full confidence, pin the blame on one or the other proffered explanations. Our analysis did yield evidence of a small rise in inflation expectations. As we also pointed out, however, the stock market’s strong recent performance lends some support to Powell’s contention that rising expectations with respect to future economic performance have fueled the jump in bond yields.
Given his position as chief architect of monetary policy, though, Powell may be predisposed to see things that way. If inflation risk truly is rising, then with 20/20 hindsight, market commentators will ultimately see the Fed’s recent easing as a policy error. The chorus will include not only critics of Powell who are already saying the rate cuts were ill-considered, but others who for the time being are giving him the benefit of the doubt. Only time will tell whether Powell and his FOMC associates will in the end be credited by the Monday morning quarterbacks with the rare feat of achieving a soft landing or faulted for reigniting US inflation.
For our part, we expect inflation to remain moderate in the near to intermediate term. A re-steepening of the Treasury yield curve, entailing some rise in intermediate- and long-term yields, is a normal response when the Fed shifts toward easing. We believe investors should continue to allocate to fixed income a portion of their portfolios appropriate for their circumstances, with an emphasis on the 3-to-7 year “belly” of the yield curve.
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