Following weeks of weak labor market data, the Federal Reserve is likely to deliver a widely expected quarter-point rate cut today, marking the start of a new easing cycle. Markets have seen this before: in September 2024, the Fed initiated rate cuts from a 5.5% ceiling with an initial 50-basis-point move, followed by two additional quarter-point reductions. Yet instead of a smooth decline, the 10-year Treasury yield surged roughly 120 basis points between September and December 2024, reversing its pre-cut decline.
That episode highlights the risk of an overshoot. The 10-year SOFR rate troughed near 3.15% last fall before climbing toward 4.30%, while the 10-year Treasury yield peaked near 4.80% by year-end. A similar dynamic could unfold again: yields initially dip as markets price in easier policy, only to back up amid concerns about inflation, fiscal pressures, and macro resilience.
When the Fed began cutting rates in September 2024, inflation had cooled to the 2.5% area and looked set to drift lower. By contrast, today’s inflation picture is less favorable—running closer to 3% and poised to climb higher in the coming months as tariffs add to price pressures. At the same time, fiscal dynamics have worsened. Tariff revenues have fallen short of expectations, scheduled tax cuts loom in 2026, and spending remains unconstrained. These elements create the conditions for upward pressure on long-term yields, even if the near-term direction points lower.
Down First?
The “down first” phase appears imminent. The 10-year yield, now hovering near the key psychological 4% level, has scope to break lower in the weeks ahead, perhaps to 3.75%. This would align with a 10-year SOFR rate trough near 3.25%, which represents a realistic floor based on the expected bottom of the Fed’s rate-cutting cycle (2.75%–3.00%) plus a 50-basis-point spread. With the current SOFR rate at 3.55% and inflation expectations not yet validated, markets may temporarily accept near-zero or even negative real rates.
Yet, these levels are unlikely to hold. If inflation prints creep toward the 3.5% area, as many expect, the market will likely reassess. Even if the tariff impact proves more a one-off price adjustment than a sustained inflation surge, investors may grow uneasy with deeply negative real yields. In such a scenario, the 10-year SOFR rate could back up above 3.5%, and the 10-year Treasury yield could climb toward 4.5%, restoring a more balanced risk premium.
The broader curve implications fit historical precedent. A 100-basis-point spread from the funds rate to 10-year SOFR or a 150-basis-point spread to the 10-year Treasury yield is consistent with historical norms, especially given that a 150–200 basis point term premium has often characterized past cycles. In short, while bonds may rally initially as the easing cycle begins, structural inflation and fiscal pressures suggest higher long-end yields are likely to follow.
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