Why have 10-year U.S. Treasury yields increased since the Fed started cutting rates?

The United States consistently outperformed growth expectations throughout 2024. Economists initially expected the economy to grow by 1.2% for the year; however, as we closed 2024, that estimate more than doubled to 2.7%, with a significant portion of that adjustment occurring in Q4 alone. Robust growth exceeding expectations puts upward pressure on yields as the anticipated number of rate cuts by the Fed decreases.

Economic uncertainty is another major factor contributing to the upward pressure on yields. Questions remain about where Fed rates will land over the next year or two, and what the new administration’s policies might mean for inflation and the Fed’s outlook. There is already approximately 150 basis points of variance among FOMC members regarding where rates should settle.

For what it’s worth, the most recent sell-off in bond yields doesn’t seem to reflect increased concerns about the U.S. deficit. The yield on longer-dated government bonds compared to interest rate swaps (which don’t face the same supply and demand dynamics) has remained stable since the middle of last year. This contrasts with the rising discount assigned to long-dated sovereign debt in the United Kingdom, where investors have expressed more concern over the country’s ability to service its debt.

At present, we think rate hikes are off the table. The labor market hasn’t retightened, and sectors sensitive to interest rates are still lagging. Increases in wages paid to employees peaked in 2022 at 5.1%; since then, that figure has continued to decline to 3.9%. In other words, employers believe they can offer smaller wage increases without risking employees leaving for other jobs. So far, that has been the case. The quits rate, which can be a proxy for labor force confidence (employees are less likely to quit their jobs if they don’t believe they can find another), has fallen to a five-year low. Moreover, interest-rate-sensitive sectors have underperformed the broader market since the spring of 2023, when the fed funds rate peaked above 5%. As we approach the rate that neither stimulates nor restricts economic growth, we would expect that performance gap to narrow.

So we think the Fed won’t hike rates, and thus rates are priced aggressively high for that scenario. What does this mean for portfolios? It means we are more comfortable adding duration at these levels than we have been for months. For U.S. taxpayers, moving from cash into municipal bonds—which have yields above their 25-year average—can provide tax-advantaged income and an opportunity for capital gains amid falling yields. For investors outside the United States, European duration trades at elevated yields. And for those looking to take on extended credit risk, U.S. preferreds and direct lending offer near double-digit yields.