(Mike Maharrey, Money Metals News Service) Treasury yields are rising even as the Federal Reserve cuts interest rates.
This is a big problem for Uncle Sam, who is already struggling to pay for its borrow-and-spend addiction.
The central bank has dropped interest rates by 100 basis points since it started easing monetary policy with a super-sized cut in September. Since then, long-term Treasury yields have gone up by over 100 basis points.
Yields hit their low point on Sept. 16, two days before the first Fed rate cut. Since then, the 5-year Treasury yield is up by 106 basis points, the 7-year yield has risen by 105 basis points, the 10-year yield has increased by 100 basis points, and the average 30-year fixed mortgage rate is also up by 100 basis points.
Why Is the Federal Reserve Cutting Rates?
Good question. Because, on the surface, its aggressive monetary loosening doesn’t really make much sense.
The Fed is ostensibly cutting rates because Powell & Company believe they have beaten back inflation.
But they haven’t.
The CPI continues to signal sticky price inflation. None of the Fed’s inflation metrics are at the mythical 2 percent target. Core CPI, excluding more volatile food and energy prices, has been mired at 3 percent for months. Producer prices rose at an alarming rate in November.
Despite the data and even some voices of concern about sticky price inflation, the Fed still delivered another rate cut at the December meeting.
So, the “inflation is beat” mantra doesn’t fly.
Generally, central banks start cutting rates when recession warning signs begin flashing. But GDP is growing. The Federal Reserve insists that the labor market is strong, and despite some recent signs of softening, Fed officials insist it won’t likely weaken further.
Sure, there are some cracks in the economy if you know where to look. But the mainstream narrative is we have a strong economy, and the Fed is guiding us to a soft landing.
As WolfStreet put it, “This time around, the Fed cut amid above-average economic growth with no recession in sight – so that’s unusual – and longer-term yields have risen amid this solid economic growth.”
Either the Fed is secretly worried that the economy could crash, or there is some other reason for the recent monetary easing.
I’m speculating, but I think the real reason the Fed has slashed rates is they know this debt-riddled bubble economy can’t function long-term in a higher interest rate environment (even though rates are still historically low.) They might not see a crisis on the horizon, but they know they’ve created that potential, and they’re trying to walk a tightrope between price inflation and an economic meltdown.
The upward-spiraling national debt highlights the interest problem. Last year, the federal government’s interest expense eclipsed $1 trillion for the first time in history. It was the second biggest spending category in 2024, bigger than national defense and bigger than Medicare. The only spending category that was bigger was Social Security.
This is a big problem for the U.S. government as it continues to run massive deficits with no indication it will address its borrowing and spending problem in the near future. It needs lower interest rates to drive its borrowing costs down.
And Uncle Sam isn’t the only one feeling the debt crunch. Consumers and businesses are also levered to the hilt.
So, I think one of the quiet reasons the Fed is cutting rates is its attempt to provide some relief for the debtor nation.
The problem is it’s not working.
The Bond Market Is Nervous
Rising Treasury yields reveal a dirty little secret. The central bank has a limited ability to control the long end of the yield curve. It can drive short-term rates lower through monetary policy, but other factors are driving long-term interest rates – namely supply and demand.
Rising yields not only signal investors have bought into the “soft landing,” strong economy mantra, but they also expose a couple of significant concerns.
- The re-emergence of price inflation.
- Concern about the federal government’s fiscal irresponsibility.
As WolfStreet put it, “There are rising concerns in the bond market about the ballooning US debt, and about the flood of new supply of Treasury securities that the government will have to sell in order to fund the out-of-whack deficits. Treasury buyers and holders are spread far and wide, but higher yields may be necessary to reel in the mass of new buyers needed, even as the Fed is shedding its Treasury holdings through QT.”
“These are worrisome thoughts for potential buyers of long-term Treasury securities; they want to be compensated through higher yields for the risks of higher inflation and the risks this flood of new supply might bring.”
It’s quite possible that the Fed won’t be able to lower federal borrowing costs even with deeper interest rate cuts. As already mentioned, the central bank can move the short end of the rate curve, but it has a much harder time manipulating long-term rates. There are too many other contravening factors.
Ultimately, the federal government needs the Fed to step in and put its big fat thumb on the bond market. That would mean a return to quantitative easing (QE).
In QE operations, the central bank buys Treasuries on the open market. This increased (artificial) demand drives bond prices higher and puts downward pressure on yields. This would be an ideal scenario for the U.S. government. It needs all the help it can get to facilitate its borrow/spend addiction.
But the Fed runs QE operations with money created out of thin air. The new money gets injected into the monetary system and the economy. This is, by definition, inflation.
In other words, the Fed is between a rock and a hard place. It needs to get interest rates down for the Treasury (Fed officials claim they don’t care about the government’s fiscal issues, but I call BS.), but doing so runs the risk of reigniting price inflation.
Mike Maharrey is a journalist and market analyst for MoneyMetals.com with over a decade of experience in precious metals. He holds a BS in accounting from the University of Kentucky and a BA in journalism from the University of South Florida.
