Why Are Interest Rates Rising When The Fed Has Been Cutting Them?

The current situation on Wall Street is perplexing and seems counterintuitive.

Recent fluctuations in the bond market have pushed the yield on the 10-year Treasury to over 4.80%, marking its highest point since 2023. This surge in yields has created anxiety among investors and contributed to declines in U.S. stock market indexes.

This bond market activity might seem odd, especially since the Federal Reserve has implemented three interest rate cuts starting in September. However, it serves as a reminder that market investors tend to prioritize future conditions over present ones. Presently, the bond market is expressing concerns regarding possible inflation spikes and an economy that may not require further assistance through lower interest rates. Such worries are negatively impacting stock prices.

Since September, the Fed has lowered its main interest rate by one percentage point in an effort to support the economy after previously raising rates to a two-decade high to help curb inflation. However, the Fed's ability to affect the interest rates that are impacting the stock market, particularly the 10-year Treasury yield, is somewhat limited. The federal funds rate, which the Fed controls, is a short-term interest rate that determines what banks charge each other for overnight borrowing.

In contrast, the yield on the 10-year Treasury is influenced largely by investor decisions. While these investors consider the Fed's rate cuts when determining how much yield they need to invest in Treasuries, they also weigh projected economic growth and inflation. Interestingly, the yield on the 10-year Treasury began to rise in September, coinciding with the initial cuts in the federal funds rate.

The increase in the 10-year yield, which rose from 3.65%, aligns with rising expectations for both economic growth and inflation. This shift is largely attributed to a series of positive reports suggesting that the U.S. economy is performing better than many anticipated, even though inflation remains stubbornly persistent. Nonetheless, a recent reading has offered a glimmer of hope and led to a decrease in Treasury yields.

Historically, a similar occurrence took place in late 2018 but in the opposite direction. During that time, the Fed had been raising the federal funds rate since early 2017, and the 10-year Treasury yield also increased. However, as we approached the end of 2018, the 10-year yield started to decline, continuing even after the Fed raised rates in December 2018, as markets correctly forecasted that rate hikes would soon cease.

Political factors, particularly those surrounding President-elect Donald Trump, also play a significant role. His plans for tariffs on imports could lead to increased inflation, while his inclination towards lower tax rates might further inflate the U.S. government’s debt, prompting investors to demand higher interest rates due to the increased risk.

The Federal Reserve has recently cautioned that it may only reduce interest rates twice in 2025, following earlier expectations of four cuts. Many traders on Wall Street are now contemplating whether the Fed will even make any short-term rate cuts in 2025.

Even last week's better-than-expected results regarding inflation did not give the market a comprehensive sense of security. As Gary Schlossberg, a market strategist at Wells Fargo Investment Institute, stated, "We believe it likely will take several months of slowing inflation to get the Fed — and the market — thinking about another rate cut.”

interest, rates, bonds