Fed Should Shoulder Blame for Ongoing Bond Market Collapse
As investors wonder whether the U.S. 10-year bond will break above a 5% milestone, the U.S. faces an uphill battle ahead.
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From being one of the most boring asset classes to one that has been collapsing now for the past three months, bonds have come front and center in most trading room discussions.
The question being deliberated is whether the U.S. 10-year bond will break above 5%, the psychological key level where it stood back in November 2023 when Janet Yellen changed the course for bonds as the market neared a breaking point. Will these levels today compel the Federal Reserve or U.S. Treasury to pull a rabbit out of their hats once again?
Every podcast or sell-side report browsed over the past few weeks has only mentioned one thing: U.S. bond yields! Chartists and technicians keep drawing zig-zag lines to predict the floor as the bonds, especially TLT, make a new floor. It really is the Fed's fault that this is happening.
It was too trigger happy to cut rates after the summer when the data softened seasonally. This scared it into an emergency rate cut of 50 BPS in September. Even though the seasonal scare was dismissed and the data got stronger, the Fed still went on ahead and cut in November and December. Bonds have fallen for the past quarter. The front yields have rallied about 100 BPS as the Fed cut by 100 BPS. That was the mistake, as inflation had come down but it was sticky, and this should have convinced it to pause rather than cut.
The bond market has been worried about a Fed policy mistake for months now. But we know the Fed's dilemma: It needs to cut rates as soon as possible to save its U.S. interest bill and boost consumer and mortgage demand.
At 30-year yields north of 7%, no one is able to take out a mortgage, let alone even think of buying a home. What made matters worse is that incoming president Donald Trump's policies around deregulation, deportation and tariffs are seen to be even more inflationary, allowing bonds to fall more. As business friendly as he may be, inflation and yields are a huge concern to risk assets as asset prices will need to be repriced at higher yields.
DOGE wants to cut about $2 trillion in government inefficiency, which can lead to a slowdown as all of this spending has been keeping the economy afloat. There is talk of productivity post all the AI capex investment, but there may be some time before it is truly felt. In the meantime, the U.S. has a huge debt problem, one which means it will need to keep printing more money to just pay down that debt and more to keep the economy going. So, the U.S. economy is in the weak spot as the transition takes place.
The dollar is the most prevalent asset for now, aka the wrecking ball, as all this talk of tariffs has seen the dollar rally aggressively against all other currencies, especially the yen, yuan, Canadian loonie and sterling. This is causing havoc in countries that have dollar debt as it keeps getting marked higher, especially China, as it is unable to stimulate its economy by printing more, lest its currency fall even furhter.
Trump would like a lower dollar and lower rates, but is that really possible without a recession? The bond market and the dollar seem to be linked as the higher U.S. dollar debt externally means more treasuries and U.S. assets will need to be sold to finance that debt. Will Trump allow that to happen?
Time shall tell, but all eyes are on the dollar here as that is what is driving this, not inflation. At least not yet, until the recent oil rally, which could make Trump and the Fed's life even harder. So, who blinks first?
At the time of publication, Bengali had no positions in any securities mentioned.
