Chart of the month: Bonds buck the trend

Our chart of the month for November looks at the bond market impact of the start of the Federal Reserve’s (Fed’s) rate cutting cycle. 

As a reminder, the Fed lowered its target rate by 50 basis points (bps) in late-September in response to deteriorating labour market data and a perception that the fight against inflation was largely won. It followed up with another 25bps cut in early November. Its strong steer is that we should expect more to come, with guidance that rates will be cut by another 125bps by the end of 2025. Despite those messages, the bond market has sold off sharply in the last six weeks, with 10-year yields rising by around 70bps. 

As our chart shows, this is unusual market behaviour. The grey lines show the change in 10-year yields in the first six weeks of all rate-cutting cycles since the mid-1980s.

The only remotely comparable period in recent history came in mid-1995. During that episode, the Fed started cutting rates in the summer as it became concerned about a sluggish economy and the potential for a fiscal crunch in the second half of the year. Both concerns faded and the economic expansion rolled on until the end of the decade. The cutting cycle was over barely six months after it started. 

Could history be repeating itself? Money market traders don’t think so. For now, the short end of the US yield curve prices in another 85bps of rate cuts over the next year. 

But firmer inflation than anticipated could get in the way, and the real wildcard is the potential for a fiscal splurge under the Trump administration – even though its recent rhetoric has focused on government efficiency. 

We worry that the market will focus more on the prospect of imminent tax cuts than the hope of longer-term spending restraint and don’t see sufficient compensation for that risk (yet) in the US Treasury market.