What Are U.S. Treasury Yields Telling Us? — Evening Brief – 01.21.25
Reflation risks are becoming more evident, with recent data pointing to stubborn inflationary pressures in key areas of the economy. The services sector, often a bellwether for inflation trends, has shown rising momentum, fueling concerns that disinflationary progress may be reversing. This is particularly notable in categories like housing, healthcare, and professional services, where costs remain elevated due to structural factors and strong demand.
While off its 8-month peak of 4.89%, The U.S. 10-year Treasury yield, often seen as a proxy for inflation expectations and economic growth, has remained elevated in response to these signals. Meanwhile, the policy-sensitive US 2-year yield has risen to 4.38%, the highest level since late July.
As a result, the yield is trading in line with the current Fed funds target rate at 4.25% to 4.50%. This marks the first occasion in almost two years that the 2-year yield has not traded below the federal funds target rate. This also marks a significant shift, as the 2-year yield typically trades below the Fed funds target rate during periods of anticipated monetary easing.
Renewed inflation concerns complicate the Federal Reserve’s path forward, especially with market expectations for additional interest rate cuts clashing with sticky inflationary pressures.
The U.S. 10-year Treasury yield’s ongoing upward trend, coupled with its golden cross—where the 50-day moving average crosses above the 200-day moving average—provides technical evidence supporting a continuation of this bullish momentum.
Growing concerns that sticky inflation will persist, perhaps leading to a period of reflation, along with fiscal policy uncertainty, is likely the motivating factor. Recent economic news fueled that concern via the strength in the December ISM services price index — marking the highest reading since January 2024, and the most recent CPI data, where Core CPI was tamer than expected but the monthly headline rose to its highest level since last March, while the annual print was the highest since last July.
Concerns about firmer inflation risks are indeed tied, in part, to anticipated policy changes by the new Trump administration. Overall, “You’re getting a recalibration of inflation expectations and Fed rate expectations,” said Tom Hainlin, senior investment strategist at U.S. Bank Asset Management Group.
The outlook for inflation and monetary policy remains uncertain, leaving room for discussion about whether current Fed strategies are sufficient to address potential pricing pressures. Meanwhile, interest rate cuts are unlikely in the immediate future, and rate increases may become a topic of discussion.
In this environment, the Fed is likely to proceed cautiously, responding to evolving data on inflation, employment, and economic growth. Meanwhile, the Treasury market is requiring a greater premium in yield to mitigate potential repercussions if the Federal Reserve has committed a policy blunder by prematurely reducing interest rates in recent months.