We expect the 10-year Treasury yield to remain in a range between 4% and 4.5% amid elevated volatility and now expect it to finish the year near 4.35% with risk of a lower rate depending upon the Federal Reserve’s appetite for rate reductions.
At this point, we expect the Fed to make only one rate cut this year, most likely in December, as the economy chugs along at sub-2% growth and central bankers assess the impact of tariffs and the expansionary fiscal policies that were recently signed into law.
We do not see a large downward move in the 10-year yield because of the interplay among fiscal, trade and monetary policies.
Get Joe Brusuelas’s Market Minute economic commentary every morning. Subscribe now.
Beyond the direct influence of monetary policy, interest rates are determined by expectations of economic growth and the ability to sustain higher rates of return. Low interest rates imply an economy unable to support normal rates of return,
The years of near-zero interest rates after the financial crisis and then the pandemic were aberrations that reflected a struggling global economy.
The yield on a 10-year Treasury bond on July 9 stood at 4.33%, which can be broken down to its components of the real, or inflation-adjusted, rate of 1.99% plus the compensation for the break-even rate of inflation of 2.34%.
Another model of the 10-year yield is derived from expectations of a federal funds rate of 3.64% plus a term premium of 0.64% to compensate for the risk of holding that bond until maturity.
The presence of a term premium accounts for the Fed’s not being able to sustain that 3.64% rate over 10 years because of an inflation shock or a growth shock.
Range trading and a center of gravity
It takes a catastrophe to move long-term interest rates away from what were appropriate levels of risk and expectations of inflation, and then it takes years for the economy and the bond market to recover.
The drop in the 10-year yield during the 2018 trade war is a prime example of a manufactured crisis. The precipitous drop during the pandemic is an example of the impact of a natural disaster.
It took three years for markets to recover from the pandemic and to finally respond to the delayed impact of the fiscal stimulus. Since 2023, 10-year yields have range-traded around 4.25%, which is its 52-week average.
We can expect that range to hold for as long as the economy remains at full employment or until inflation overwhelms household expenditures.
Read the full analysis at The Real Economy Blog.
