Wall Street’s recent movements in the bond market seem counterintuitive. The yield on the 10-year Treasury recently surpassed 4.80%, reaching its highest level since 2023. This has created uncertainty in the U.S. stock market and caused stock indexes to fall from their record highs.
At first glance, the bond market’s behavior might appear odd, especially considering the Federal Reserve’s decision to reduce interest rates three times starting in September.
However, this situation serves as a reminder that markets are more focused on the future than the present. The bond market is expressing concern about the possibility of higher inflation ahead, as well as a U.S. economy that may not require further assistance from lower interest rates. This uncertainty is negatively impacting stock prices.
Since September, the Fed has cut its main interest rate by one full percentage point. The aim is to provide relief to the economy after the Fed raised the federal funds rate to a two-decade high earlier, intending to slow down the economy enough to control inflation.
However, the Fed’s influence is limited when it comes to the interest rates that are currently affecting the stock market, particularly the 10-year Treasury yield. While the Fed controls the federal funds rate— a short-term interest rate that determines what banks charge each other for overnight borrowing— it does not directly set the 10-year yield.
The 10-year Treasury yield is determined by investors, who consider the Fed’s actions when deciding the return they expect from U.S. Treasurys before lending money to the government. But they also account for the direction of the economy and inflation.
Ironically, the 10-year Treasury yield began rising in September, when it reached 3.65%. This increase occurred just as the federal funds rate started to decline for the first time since 2020.
Federal Reserve System
The 10-year yield rose, even as the Fed cut overnight interest rates, because investors were anticipating economic growth and higher inflation.
Much of this optimism was driven by a series of reports indicating that the U.S. economy was more resilient than expected. Inflation was also proving to be more persistent, though recent data has provided some hope, leading to a slight reduction in Treasury yields.
A similar situation occurred in late 2018, but in the opposite direction. The Fed had been raising the federal funds rate since early 2017, and the 10-year Treasury yield had been rising during that period.
However, the 10-year yield started to decrease before the end of 2018. It continued to fall even after the Fed raised the federal funds rate in December 2018, as investors anticipated that rate hikes would halt before putting too much strain on the economy.
In addition to the Fed’s actions, President-elect Donald Trump is also a significant factor in the current economic landscape. His proposals to impose tariffs on imported goods could drive up inflation, while his preference for lower tax rates could exacerbate the U.S. government’s debt, leading investors to demand higher interest rates to compensate for the added risk.
The Federal Reserve recently warned that it might only cut interest rates twice in 2025, down from its previous projection of four rate cuts. Traders on Wall Street are now questioning whether the Fed will cut short-term interest rates at all in 2025.
Even Wednesday’s better-than-expected inflation data was not enough to reassure the market. “We believe it will likely take several months of slowing inflation to get the Fed—and the market—thinking about another rate cut,” said Gary Schlossberg, a market strategist at Wells Fargo Investment Institute.
