Rising treasury bond yields since the beginning of 2025 could indicate that bond investors are not confident the Fed has inflation expectations anchored, as it claims.
“Inflation has eased significantly over the past two years but remains somewhat elevated relative to our 2% longer run goal estimates,” Fed chair Powell said in January 2025 and he added, “longer-term inflation expectations appear to remain well anchored,”
Three surveys were cited regarding where households, businesses, and forecasters see inflation going in 2025.
All three surveys supported the Fed’s narrative that long medium-term inflation expectations have been anchored. In other words, households, businesses and forecasters expect inflation to be under control, albeit in the second half of 2025.
However, the anomaly to the narrative of longer-term inflation expectations being anchored is price action in the treasury bond market.
Darren Winters asks, why are treasury bond investors not partying like it’s 1999 if they believe long-term inflation expectations are under control?
Think about it. If bond investors expected long-term inflation to be anchored, as the Fed chairman Powell claims, they ought to be buying frantically treasury bonds to lock in those high yields.
Instead, what is playing out in Q1 2025 is a continuation of a gold bull market, with the 10-year treasury bond yield near its 52-week high of 4.42 at the time of writing.
Moreover, the 5-year breakeven inflation rate rose to 2.64% this month, the highest since March 2023, having shot up by 78 basis points since just before the Fed’s September rate cut. This measure (5-year Treasury yield minus the 5-year Treasury Inflation-Indexed Real Yield) shows what the bond market saw this month as the average inflation rate over the next five years.
The Fed has cut by 100 basis points, while this measure of market-based inflation expectations for average inflation over the next five years has shot up by 78 basis points.
Inflation expectations have become unanchored, which is contrary to Fed chair Powell’s anchored narrative during the FOMC press conference.
Darren Winters explains that lacklustre demand for bonds is causing the price of the bonds to fall and its corresponding yields to rise.
Meanwhile, gold, the oldest store of value against inflation and a dodgy system, continues to rally in Q1 2025.
Gold is at a record high of 2,959 USD.
Rising treasury bond yields and a gold rally underscore a market that believes inflation expectations are unanchored
If investors believed inflation was under control capital flows would be rotating from gold into treasury bonds, bearing in mind the latter is also perceived to be a store of value with the added benefit of yields.
The opportunity cost of holding gold is the forgone treasury bond yields.
But price action in the bond market is telling a story that bond investors are okay with losing 4.4% annual yields currently offered on the 10-year treasury because they perceive the maturity risk, due to inflation, of holding bonds to be worse than the yields gained.
Rising treasury bond yields could be why the Fed is desperately pivoting, to wait and see before any future rate cuts
Bond investors are starting to fret that inflation is not under control.
US 10-year Treasury Note yields over three months show rising yields.
Quantitative tightening QT could be causing rising treasury bond yields
When the Fed reduces the size of its assets on the balance sheet by selling assets, that drains liquidity from the market, causing asset prices to fall.
The Fed is still doing QT, bearing in mind the total assets on the Fed’s balance sheet declined by $42 billion in January, to $6.81 trillion, the lowest since May 2020, according to the Fed’s recent balance sheet.
Treasury securities are -$25.2 billion in January and -$1.51 trillion from its peak in June 2022, or -26% since the peak, to $4.27 trillion, the lowest since July 2020.
So the Fed has now shed 46% of the $3.27 trillion in Treasuries heaped on the balance sheet during pandemic QE.
By implementing QT policy the Fed is allowing rising treasury bond yields
The Fed is even reducing the size of its Mortgage-Backed Securities (MBS).
MBS -$15.7 billion in January, -$522 billion from the peak to $2.23 trillion, the lowest since May 2021.
The Fed has shed 19.1% of its MBS since the peak in April 2022.
Regarding the MBS that the Fed had added during Pandemic-QE, it has shed 38%.
Rising bond yields, QT, plus Doge spending cuts could trigger a sharp recession
So, we still have monetary contraction. QT is draining liquidity from the markets.
Moreover, with Q4 GDP at 2.3% and the current Fed fund rates of 4. 25 to 4.5%, those Fed fund rates are also in contractionary territory, despite last year’s 100 basis points Fed rate cuts.
Meanwhile, public spending is being slashed.
The latest with the head of DOGE, Elon Musk, standing on stage with a chainsaw, symbolizing mammoth cuts coming.
DOGE, one month into being, is claiming $55 billion in cuts already, but that is just the tip of the iceberg.
Musk’s ambitious goal for DOGE is a massive $500 billion cut by next July,
But public spending cuts equals job losses.
Probationary firings could affect 200,000 employees.
The Department of Defense may see 8% of staff laid off, according to The Hill. Meanwhile, Washington DC unemployment rates are rising sharply as unemployment claims surged 55% in 6 Weeks.
Rising treasury bond yields mean more expensive credit and fewer private investments
US business activity nearly stalled in February amid mounting fears over tariffs and deep cuts in federal government spending.
Darren Winters sums up; at some point, rising treasury bond yields combined with unprecedented public cuts and a potentially sharp economic contraction on the cards could trigger investor interest in treasury bonds.