(Bloomberg) — The last time U.S. government bonds sold off this much when the Federal Reserve started cutting interest rates, Alan Greenspan was orchestrating a rare soft landing.
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Two-year yields have risen 34 basis points since the Fed cut interest rates on September 18 for the first time since 2020. Yields similarly rose in 1995, when the Fed – led by Greenspan – managed to cool the economy without causing a recession. In previous rate-cutting cycles dating back to 1989, two-year bond yields fell on average by 15 basis points one month after the Fed began cutting interest rates.
The rise in yields “reflects a lower probability of recession risk,” said Steven Zeng, interest rate strategist at Deutsche Bank AG. “The data came in very strong. The Fed may slow the pace of interest rate cuts.
The latest back-up in yields shows how a resilient U.S. economy and buoyant financial markets are limiting the options available to Federal Reserve Chairman Jerome Powell to aggressively cut interest rates. Interest swaps show that traders expect the Fed to cut interest rates by 128 basis points through September 2025, compared to 195 basis points priced in about a month ago.
Global bonds fell this week as investors weighed the prospect of slower interest rate cuts, leaving a measure of the total return in Treasuries up just 1.7% this year through Monday. This follows a 4.3% increase in Treasury bills during that period.
The selling extended slightly on Tuesday, pushing the 10-year bond yield up about 1 basis point after an 11 basis point increase on Monday. The latest rise has lifted the yield on the benchmark index to about 4.2%, up from a 15-month low of 3.6% on Sept. 17 — a day before the Fed cut borrowing costs by half a point.
On Tuesday, trading activity indicated that sentiment remains bearish, with a series of block trade sell-offs in 10-year bond futures. In the options market, one trade targets 10-year bond yields rising to around 4.75% by the option expiration on November 22.
In 1995, the Fed cut interest rates just three times – from 6% to 5.25% – in six months, after raising them sharply. Yields on 10-year bonds jumped more than 100 basis points 12 months after the first cut that year, while two-year yields rose 90 basis points.
This time, the rise in yields also reflects growing concerns that the Republican Party may take control of the White House and Congress in the November 5 elections, which could lead to a strengthening of the federal deficit and inflation.
Volatility has also increased. The ICE BofA Move Index, which tracks expected volatility in Treasuries next month, rose to its highest level this year.
– With the assistance of Edward Bolingbroke.
(Update prices in fourth paragraph.)
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