Another Federal Reserve rate cut, another … rise in interest rates? That is the current dynamic across the Treasury yield curve — the real-time market rates — a week after the Fed’s first cut in policy interest rates in nearly a year. Many consumer loans, such as home equity and mortgages and credit cards — and even bank deposits, take their cues from bond yields. The key questions for investors now are: Why is this happening? And … what, if anything, should we do? The answers to both questions start with the bind the Fed finds itself in as it contends with its two mandates – fostering price stability and maximum employment – that are currently in opposition of one another. Lately, signs of a slowing labor market have become more worrisome to the Fed than an uptick in overall inflation. The former, of course, supports rate cuts to stimulate employment demand, while the latter argues for keeping rates high to clamp down on rising prices. While the Fed has made it clear that the job market needs to be in the driver’s seat, the bond market is not so sure. When it comes to bonds, the yields are locked in when purchased. So, buying a 10-year Treasury , or lending the U.S. government money for the next decade, the current yield of roughly 4.2% is what you are stuck with until maturity. (Bonds are traded all the time before they mature, leading to fluctuations in yields, which move inversely to price. But that’s a whole other story.) As a result, you have to think about real returns – the yield minus the rate of inflation – on a time horizon equal to when the bond will mature. In other words, before locking in a rate for 10 years, you need to consider what inflation may look like over the decade. Miscalculate and assume too low a rate of inflation, and you will end up getting a lower, possibly even negative return over that investment horizon in real terms – real terms is what matters, as it speaks to buying power. To be sure, we are not saying that the Fed was wrong to cut rates by 25 basis points last week. We have previously argued that the labor market deserves more focus because if inflation does indeed pick up due to tariffs, that stands to be more transient in nature than a rise in unemployment. That’s especially true if unemployment prompts businesses to adopt artificial intelligence solutions more quickly – and in turn, become structurally less reliant on human labor. Horse and buggy repairman, anyone? Tariffs, on the other hand, are likely more of a one-time phenomenon. While the price increases will remain, the rate of price increases will decline as we lap the date of implementation. However, with inflation still above the Fed’s 2% target and central bankers cutting policy rates that impact the low end of the bond market yield, it’s clear that bond market traders feel they must hedge against the move. Put another way, to protect against a rebound in inflation aided by the cut on the short end to protect the job…
Read More: The Fed rate cut is not working. Here’s why, and what to do as a stock