Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the 10-Year Treasury Yield Is Falling Despite Sticky Inflation
Transcript
- Lucas: The 10-year Treasury yield has dropped about 15 basis points in the last five trading sessions. It's sitting at 4.37 percent as of Friday's close. That's a notable move for a week where we didn't get a clear dovish signal from the Fed. Luna: And yet core PCE came in at 3.4 percent, the highest since late 2023. That feels contradictory — sticky inflation, but bond yields falling? Lucas: It does. But the bond market is looking past the inflation print and focusing on something else: the growth outlook. The 10-year breakeven rate, which is the market's expectation for average inflation over the next decade, actually slipped to 2.20 percent. That's down from 2.21 percent the day before the PCE release. Luna: So the bond market is saying inflation expectations are contained, or even softening a bit. But the nominal yield is dropping even more sharply. Lucas: Right. The nominal yield equals the real yield plus inflation expectations. If breakevens are barely moving but nominal yields are falling, it means the real yield component is declining. That's the market pricing in weaker real growth expectations. Luna: A growth scare. And we see that in the curve, too. The 2-year yield is at 3.66 percent, the 10-year at 4.37 — that's still inverted by about 70 basis points. Lucas: Exactly. An inverted yield curve that steepens because the long end falls faster than the short end is actually a classic recession signal. It's not just that the curve is inverted — it's that the inversion is driven by collapsing long-term yields. That's what we're seeing. Luna: And the 30-year bond yield dropped to 4.86 percent, down 1.7 percent in a week. That's a big move for the long bond. Lucas: It is. The long bond is the most sensitive to growth expectations. When investors think the economy is going to slow down, they pile into long-duration Treasuries, pushing yields down. The question is: is this a genuine growth scare or just a repositioning after the equity sell-off? Luna: The NASDAQ dropped 3.3 percent this week. The S&P 500 fell 1.6 percent. There's clearly some risk-off sentiment. Lucas: But the Dow actually gained 0.3 percent. So it's not a uniform flight to safety. It's more sectoral. Tech is getting hit, maybe on valuation concerns or the tariff headlines, while industrials and financials held up. That's not a classic recession signal — that's a rotation. Luna: Let's talk about what the Fed is seeing. The fed funds rate is at 3.63 percent. The 2-year yield is almost exactly at that level. The market is pricing in that the Fed is done hiking, but also that they won't cut anytime soon unless growth really deteriorates. Lucas: That's the interesting part. The bond market is telling us the next big move in rates is down, but it's not imminent. The Fed's own dot plot probably shows a cautious stance. If core inflation stays above 3 percent, they can't cut. But if the bond market is right about growth slowing, they might have to cut into sticky inflation. Luna: That's the nightmare scenario for central banks. Stagflation-lite. Slowing growth but inflation that won't budge below 3 percent. Lucas: And the breakeven rate at 2.20 percent suggests the market thinks inflation will eventually moderate. But the path is uncertain. The 5-year breakeven is probably higher than the 10-year, which means the market expects near-term inflation to be stickier than long-term. Luna: We should step back and think about what this means for the average listener. If you're investing in bonds right now, you're essentially betting that growth will slow. If you're in equities, you're betting that the Fed will navigate a soft landing. Lucas: And the bond market is priced for a hard landing, or at least a significant slowdown. Equity markets are still near all-time highs — the S&P 500 at 7,354 is only about 5 percent off its peak. Something has to give. Either bonds are wrong about growth, or stocks are too optimistic. Luna: Which side do you lean? Lucas: I think the bond market has a better track record in predicting recessions than the stock market. The yield curve inversion has been screaming for over a year. But the economy has been surprisingly resilient. Jobless claims just fell to 215,000, which is low. The jobs market is still strong. Luna: But JOLTS job openings jumped to 7.6 million in April, up from 6.9 million. That's a big increase. It suggests demand for labor is still hot. That doesn't scream recession either. Lucas: No, it doesn't. But job openings are a lagging indicator. Companies post jobs when they're optimistic, but they can quickly pull them when sentiment turns. The factory sector has been cutting jobs at levels not seen since 2008, as we discussed a few episodes ago. Luna: So there's a split between manufacturing and services. The service sector is still strong, but manufacturing is in a downturn. That's typical of a late-cycle economy. Lucas: And that's exactly where the yield curve tends to invert. The market prices in a recession, but it takes time for the data to catch up. The bond market might be early, not wrong. Luna: Let's bring in the inflation data. Core PCE at 3.4 percent. The Fed's target is 2 percent. That's a 1.4 percent gap. If the Fed waits for inflation to come down before cutting, they might wait a long time. Lucas: But the bond market might force their hand. If long-term yields keep falling, financial conditions will ease automatically. Lower yields mean lower mortgage rates, lower corporate borrowing costs. That could stimulate the economy, which might actually keep inflation higher. Luna: So the bond market's growth scare could be self-defeating. If yields fall enough, they stimulate demand, which keeps inflation elevated, which means the Fed can't cut. It's a circular trap. Lucas: Exactly. And that's why the Fed is so cautious. They don't want to ease prematurely and reignite inflation. But they also don't want to keep rates too high and cause a recession. The bond market is essentially trying to force their hand. Luna: And the 10-year breakeven at 2.20 percent is actually below the current core PCE of 3.4. That's a big gap. The market expects inflation to fall by more than a percentage point over the next decade. That is a bold call. Lucas: It is. And if the market is wrong about inflation, long-term yields could spike. That's the risk for bond investors right now. You're getting a 4.37 percent yield on the 10-year, but if inflation stays at 3 percent, your real return is only about 1.4 percent. That's not great. Luna: Unless growth does slow, and inflation falls with it. Then the real yield is actually decent. Lucas: Right. So the bond market is making a macro bet. It's betting that the economy will slow enough to bring inflation down to 2 percent, but not so much that we get a deep recession. It's a soft landing bet, actually. Luna: But with a growth scare twist. Because the nominal yield is falling faster than breakevens, which implies real yields are dropping. That's a bet on lower growth, not just lower inflation. Lucas: Exactly. And that's the nuance we don't always hear. The bond market isn't just saying inflation will fall. It's saying growth will fall too. That's a more pessimistic view than the equity market, which is still pricing in decent earnings growth. Luna: Talking about the macro picture like this, it's why we do this show. We try to make sense of these signals without the noise. Lucas: And we deliberately keep it ad-free. No sponsors, no commercial breaks. If walking through the economy with us has made something click for you, and you want to support that choice, you can find us at buy me a coffee dot com slash fexingo. Luna: Yeah, that direct support is what keeps this independent. We appreciate everyone who's contributed. Lucas: So back to that growth scare. One other data point: the 5-year yield fell more than the 2-year this week. The 5-year is at 4.13 percent, down 3.7 percent in five days. That's the belly of the curve, which is most sensitive to the cyclical outlook. Luna: So the market is pricing in a slowdown within the next two to five years. That's consistent with an inversion that's steepening from the long end. Lucas: Right. And if you look at the shape of the curve, the 2s10s spread is about -70 basis points, but the 5s30s spread is about +73 basis points. So the curve is inverted at the front end but positively sloped further out. That's a classic 'something is wrong in the near term' signal. Luna: It's like the bond market is saying the next two years will be tough, but after that, things normalize. That's actually a relatively optimistic long-term view. Lucas: It is. And it ties back to the breakeven. The 10-year breakeven at 2.20 percent suggests inflation expectations are well-anchored. The Fed gets some credit for that. Even if actual inflation is sticky, expectations aren't spiraling. Luna: So what should listeners watch next week? Any key data releases? Lucas: We get the ISM manufacturing PMI on Wednesday. That's the big one. Manufacturing has been in contraction for months. If it stays below 50, that adds to the growth scare narrative. If it pops above 50, that could reverse some of the bond market's pessimism. Luna: And payrolls are the following week. The unemployment rate is at 4.3 percent. If it ticks up to 4.4 or higher, that's a yellow flag. Lucas: Exactly. The bond market is already pricing in weakness. The data just needs to confirm it or refute it. That's what makes the next few weeks interesting. Luna: We'll be watching. Thanks for joining us on The Macro Memo. Lucas: Until tomorrow.