The impact of the Federal Reserve's recent hawkish rate cuts is continuing to unfold in the bond market. On Thursday (December 20), the yield on the 10-year U.S. Treasury rose for the ninth consecutive trading day, reaching 4.569%, marking a rare streak since 1978. Meanwhile, the yield curve steepened to a level not seen in 30 months, with the two-year Treasury yield trailing the 10-year yield by about 27 basis points at one point, indicating a decreased demand for long-term Treasuries as safe havens.
Diverging Yields and Curve Steepening
On Thursday, Treasuries of different maturities showed diverging yield movements, with short-term yields declining and medium-to-long-term yields rising sharply. By the close of trading in New York, the two-year Treasury yield had fallen by 4 basis points to 4.329%, the five-year yield had increased by 1.6 basis points to 4.431%, the 10-year yield had risen by 4.6 basis points to 4.569%, and the 30-year yield had gone up by 6.2 basis points to 4.74%.
This divergence led to a steepening of the yield curve, a phenomenon seen as the market's reaction to long-term economic and inflation forecasts. Analysts noted that this trend is driven by the Federal Reserve's hawkish stance, potential inflation rebound, and increased pressure from expanding Treasury issuance. Investors are worried that the Federal Reserve might slow its rate-cutting pace, or perhaps restart a rate hike cycle at some point next year, further dampening demand for long-term Treasuries.
The Federal Reserve's Hawkish Signals and Policy Expectations
This week, the Federal Reserve lowered the federal funds rate target range by 25 basis points to 4.25%-4.50%, while emphasizing that future rate cuts would be more cautious. Fed Chair Jerome Powell stated that further easing will depend on progress in curbing inflation, and in the latest rate forecast, reduced the expectation of rate cuts by the end of 2025 to two 25 basis point reductions.
Though Powell made it clear that the possibility of rate hikes next year is low, the dynamics in the options market show that some traders have begun betting that the Federal Reserve might return to a rate hike cycle, especially if inflation resurfaces or economic recovery exceeds expectations.
Fiscal Deficits and Economic Policy Uncertainty
Additionally, the market is closely watching President-elect Trump's tax reform policies and their potential economic impact. Analysts suggest that if deficits worsen, more Treasury issuance may be needed to cover the gap, which will maintain pressure on the long-term bond market. Conversely, investors are more inclined to hold short-term Treasuries, further steepening the yield curve.
Long-term Trends and Market Prospects
The yield on the 10-year U.S. Treasury, seen as the "anchor of global asset pricing," has steadily climbed from a low of 3.60% in mid-September this year to its current high. Particularly since last week, the yield has risen for nine consecutive trading days, marking a rare streak not seen in 45 years. Analysts point out that this trend reflects market concerns about a long-term inflation rebound and uncertainty regarding the Federal Reserve's policy path.
Looking ahead, the trend of a steepening yield curve may persist into 2024, especially amid intensifying fiscal deficit pressures and inflation risks. Investors need to closely watch the Federal Reserve's policy developments and economic data to navigate potential market fluctuations and risks.
