Bond Market Reacts: Fed vs. Recession Outlook

Long-term bond yields rose even after the Federal Reserve made a significant move to cut interest rates. Here’s why.

On Wednesday, the Fed reduced short-term borrowing costs by half a percentage point, lowering the target range to 4.75%-5%. This was the central bank’s first rate cut in four years, aimed at providing relief to the economy.

However, Wall Street’s reaction was mixed. Instead of dropping, longer-term Treasury yields, which influence rates on mortgages, auto loans, and other credit products, climbed from their lows earlier in the week. This rise in yields suggests the market was less than thrilled with the Fed’s overall message about future rate cuts.

Cindy Beaulieu, Chief Investment Officer at Conning, explained that rates had likely fallen too quickly in recent weeks. Although the Fed’s 50 basis point cut surprised many, Fed Chair Jerome Powell signaled a cautious approach to future cuts during his press conference, indicating that the Fed isn’t in a rush to lower rates further.

Powell referred to the cut as “the beginning of this process,” and stressed that the Fed will take its time in future decisions. While this approach may seem wise, Beaulieu noted that it wasn’t exactly what investors had hoped for. She added that, given the strength of the economy and resilient consumer spending, it makes sense for long-term rates to move higher.

The 10-year Treasury yield, for example, rose 4 basis points to 3.704%, coming off its yearly lows. Beaulieu expects the 10-year yield to potentially rise above 4%, possibly reaching 4.25% by the end of the year. She warned that keeping rates too low risks signaling a recession rather than the “soft landing” investors are hoping for.

Bond market volatility has been high since the Fed began hiking rates in 2022, leading to sharp losses and disruptions across financial markets. While inflation and rate hikes no longer dominate investors’ concerns, sudden shifts in interest rates can still impact portfolios.

Karen Manna, a fixed-income portfolio manager at Federated Hermes, pointed out that both bond and stock markets often try to anticipate economic trends, but they can’t always predict what’s coming. With uncertainty still lingering, especially around a potential recovery in the housing market, Manna advised caution.

Beaulieu remains hesitant to add longer-duration bonds to portfolios, doubting the Fed’s ability to bring inflation back to its 2% target. She also expects credit spreads to widen as the November presidential election approaches, adding further volatility to the bond market.

Manna echoed these concerns, suggesting that the Fed’s next steps and the outcome of the election will likely fuel continued uncertainty. She also advised monitoring liquidity in portfolios to avoid getting stuck in illiquid assets if markets take an unexpected turn.

Stocks closed the day lower, with the Dow Jones down 0.3%, the S&P 500 losing 0.3%, and the Nasdaq Composite also dipping 0.3%.