Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Ten-Year Yield Is Stuck Below Five Percent
Transcript
- Lucas: So the ten-year Treasury yield is at 4.45 percent as of this week. That's down about nine basis points from last week, and it's been stuck in a range between 4.3 and 4.6 for most of the last two months. Luna: And that's despite core PCE inflation running at a 3.3 percent annual rate, energy prices spiking because of the Iran conflict, and the Fed holding rates at 3.64. Feels like the bond market should be screaming, but it's not. Lucas: Right. And the question is: why? Because if you just looked at the inflation data — April CPI at 332.4, up from 330.29 in March, core CPI at 335.4 — and then added the energy shock, you'd expect the ten-year to be pushing through five percent. But it's not even close. Luna: So what's holding it down? Foreign demand? Lucas: That's the biggest force. Japanese institutional investors, Chinese state banks, Middle Eastern sovereign funds — they've been net buyers of Treasuries for years. And recently, with the global growth outlook softening — Europe is basically flat, China's recovery is patchy — U.S. Treasuries are still the cleanest shirt in the laundry. Luna: So even with inflation above target, global investors are willing to accept a 4.45 percent yield because alternatives are worse. That makes sense. Lucas: Exactly. German bunds are yielding around 2.8. Japanese government bonds are at 1.1. So the spread, the premium you get for buying U.S. debt over those, is still historically wide. That keeps a bid under Treasuries even when domestic data looks hot. Luna: But there's also a domestic buyer at work, right? Pension funds and insurance companies? Lucas: Huge. The duration hedging demand from pension funds is structural. They have long-dated liabilities, and when rates are at these levels, they lock in yields by buying long-term bonds. It's not speculative — it's liability-driven investing. That creates a persistent bid for the ten-year and the thirty-year. Luna: And the thirty-year is at 4.99 percent, by the way. Just a hair below five. So the long end is flirting with that level, but the ten-year isn't even close. Lucas: Right. The thirty-year has a different set of buyers — more pension and insurance money — but the ten-year is the benchmark. And it seems like the market is pricing in a soft landing narrative: inflation stays sticky but doesn't reaccelerate, the Fed stays on hold, and the economy slows enough to keep yields range-bound. Luna: But what if that narrative breaks? What would need to happen for the ten-year to finally break above five percent? Lucas: Two things. First, a sustained move higher in energy prices that feeds through to core inflation. The Iran war has already pushed gasoline prices up — CNBC reported the average household is paying an extra $450 a year on gas and energy. If that continues, it could lift breakeven inflation expectations, which are currently at 2.39 percent. That's actually well-anchored, but it could drift higher. Luna: Second thing? Lucas: A shift in Fed communication that signals a potential hike. Right now, the market believes the Fed is done. Fed funds futures are pricing zero chance of a hike at the next meeting. But if a hawk like Kashkari or Goolsbee starts talking about the need to tighten further because inflation isn't coming down fast enough, that would repave the front end and drag the ten-year higher. Luna: And we heard from both of them this week. Kashkari told CNBC that inflation fight takes priority, and Goolsbee said energy inflation has been more persistent than expected. That's hawkish, but the market didn't react much. Lucas: Because the market is leaning against those comments with the data. The labor market is still in decent shape, but it's not overheating. The Fed's preferred inflation gauge — core PCE — came in at exactly 3.3 percent annualized, which was in line with expectations. So the market's baseline is: the Fed is patient, inflation will drift down slowly, and no hike is coming. Luna: So the ten-year is stuck at 4.45 because of a standoff between sticky inflation and strong structural demand. But how long can that last? Lucas: That's the million-dollar question. If inflation doesn't come down over the next six months — if core PCE stays above 3 percent through year-end — the bond market will eventually demand a higher term premium. The ten-year could break five percent not because of a hike, but because investors demand more compensation for holding long-term debt in an uncertain inflation environment. Luna: And if you think about it, walking through these dynamics with us every week — the interplay between inflation, Fed policy, and the bond market — that's what this show is about. And if that's been useful to you, there's a way to keep it going ad-free. Lucas: Yeah, listener support is what keeps the podcast independent. If you'd like to chip in, you can visit buy me a coffee dot com slash fexingo. No pressure, just a way to help us keep doing this. Luna: And it really does make a difference. So, back to the yield curve — the ten-year is stuck, but the two-year is at 3.59 percent, so the inversion has actually steepened a bit. Lucas: Right. The two-year is up a few basis points this week, which means the market is pricing a slightly higher probability of a hike down the road. But the ten-year isn't following, so the inversion is widening. That's usually a sign that the market expects the Fed to either cut or stay on hold while the economy slows. Luna: But we've been inverted for over a year now. That's an unusually long time. Historically, an inverted curve predicts a recession, but the recession hasn't shown up. Lucas: That's the puzzle. Some economists argue that this time is different because of the structural demand for long-term bonds. But others say the recession is just delayed. The inversion is a signal that the bond market sees trouble ahead, even if the equity market is hitting new highs — the S&P 500 is at 7,580, the Dow at 51,032. Luna: So the ten-year staying below five percent might actually be a warning sign, not a comforting one. Lucas: Exactly. If the market really believed in a soft landing, the ten-year would probably be higher — say, 4.75 or 4.8 percent — to reflect higher neutral rate estimates. The fact that it's stuck at 4.45 suggests the bond market is pricing in a future slowdown that will force the Fed to cut. That's the bond market's vote of no confidence in growth. Luna: And if that slowdown doesn't materialize, we could get a violent repricing higher. The ten-year could spike to 5.5 percent in a matter of weeks. Lucas: That's the risk. The market is positioned for a particular outcome — slower growth, stable inflation, no hikes. If the data surprises to the upside, the repositioning could be sharp. And that would hit everything from mortgage rates to corporate borrowing costs. Luna: So for now, the ten-year is caught between foreign demand and domestic hedging on one side, and sticky inflation and fiscal deficits on the other. It's a tug of war, and neither side is winning. Lucas: Right. And until we get a clear signal — either that inflation is sustainably coming down, or that the economy is weakening enough to justify cuts — the ten-year will probably stay in that 4.3 to 4.6 range. But the longer it stays there, the more pressure builds for a breakout one way or the other. Luna: And next week we get the jobs report. That could be the catalyst. Lucas: Absolutely. If payrolls come in hot — say, above 250,000 — the ten-year will test the top of the range. If they're weak — below 150,000 — we could see a rally back toward 4.3. So stay tuned.