In an unprecedented market development, Treasury bond buyers are fighting back against the Federal Reserve after Treasury yields see an unusual divergence from traditional patterns following the recent rate cuts. Right after the Fed decided to lower its policy rates by a full percentage point, long-term yields have risen by an equivalent amount, with the 10-year Treasury yield reaching 4.68% while the Effective Federal Funds Rate (EFFR) settled at 4.33%. This equal movement in opposite directions challenges historical norms, where rate cuts typically lead to declining long-term yields across the board.

One possible factor is that the driving force behind the Fed's decision was not recession but rather inflation projection and loosening labour market conditions, among other things. The economy continues to grow at an above-average pace, exceeding 3% in the second half of 2024, while the main stock index continues to perform better than the 10-year average. This unique combination of economic growth and rate cuts has created an atypical market environment, leading to a steepening yield curve after its recent un-inversion.

However, the bond market's reaction shows growing inconfidence. Investors are increasingly worried over re-inflation trends, with the December ISM services price index jumping to 64.4 from 58.2. Continued ballooning US debt and the flood of new Treasury securities needed to fund growing deficits combined with the Fed's reduced projections for rate cuts in 2025 from four to just two have led investors to dump Treasury bonds and demand higher yields on longer-term securities as compensation for the newfound risks, even as the central bank maintains its accommodative stance.

Source: Reuters, FRED, Wolfstreet, CNBC
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