The Federal Reserve just made a noteworthy move, cutting interest rates by 25 basis points—its second rate reduction since 2020. While you’d expect that to signal a dovish shift, market reactions are painting a far more complicated picture. Despite this rate cut, mortgage rates have hit their highest point since July, climbing roughly 100 basis points in the last two months. If the Fed’s intentions were to ease financial conditions, the spike in borrowing costs certainly isn’t playing along.
As of today, the Fed’s target rate sits at 4.75%, the lowest level since February 2023. Even so, interest rate futures are hinting at another 25-basis-point cut in December and further reductions of up to 100 basis points by 2025. Yet, this easing cycle hasn’t brought much relief to other parts of the financial landscape. Since the Fed began cutting rates on September 18th, yields on the 10-year Treasury note have surged from 3.60% to 4.50%, reflecting stubbornly high borrowing costs that remain in place.
Today’s reaction in the bond market was a classic case of “sell the news,” with Treasury yields selling off even as the cut was announced. It’s a familiar pattern, where the anticipation of a Fed decision gets priced in well ahead of the event. Yet, despite all this anticipation, the 10-year yield remains elevated at 4.33%, far higher than when the so-called pivot began.
Fed Chair Jerome Powell was asked to weigh in on why rates are moving higher even as the central bank cuts them. His response was that only “material changes in financial conditions that last” really matter to the Fed. He admitted the central bank isn’t certain whether recent moves in the bond market will prove durable, leaving more questions than answers about the effectiveness of current monetary policy.
Adding to the confusion is the behaviour of equities. Stock markets are seemingly ignoring the relentless rise in Treasury yields, with the S&P 500 coming within a whisker of the 6,000 mark—just 20 points shy of a milestone predicted by some analysts back in October. This market resilience is striking, especially given that earlier this year, stocks fell hard when the 10-year yield touched 5.00%. It’s as though the recent bond market turmoil is a non-event in the eyes of equity bulls, with momentum overriding concerns about rising rates.
This week has been a win for some traders. Premium alerts called for a surge in $SPX back in August, and those who followed are up a staggering 1,500 points on the index. The momentum has been relentless, but the broader narrative still hinges on inflation expectations and economic data. Currently, long-term inflation expectations sit at a relatively calm 2.1%. But should they start ticking higher, the Fed’s pivot could find itself on shakier ground.
The risk here is that inflationary pressures could resurface. Labour market and inflation data are now under an even brighter spotlight, as any surprise could change the game. If inflation expectations begin to climb, the Fed might be forced to reconsider its current trajectory, and markets could face a rude awakening.
For now, the disconnect between the Fed’s dovish actions and the market’s hawkish response is a puzzle. Trading these swings, whether in equities, commodities, or bonds, is proving to be a goldmine for the nimble. But the underlying tension between monetary policy and financial conditions remains unresolved, setting the stage for a complex year ahead.
