The puzzle of U.S. bond yields
Since inflation peaked at 9.1 per cent in mid-2022, consumer prices have cooled dramatically, job growth has dwindled from nearly 4 per cent annually to a meagre 0.9 per cent, nominal gross domestic product (GDP) expansion has halved from 10 per cent to 4.6 per cent, and commodity prices have dropped 15 per cent. Despite all of this, bond yields have stubbornly refused to ease. Mainly hovering between 4 per cent and 5 per cent – and sitting at around 4 per cent today – bullish investors argue these yields are oddly, and unjustifiably, detached from the underlying economic slowdown. Real activity has tapered and consumer price index (CPI) inflation has plummeted to 2.9 per cent. So why haven’t yields collapsed?
The Federal Reserve’s (the Fed) recent pivot to easing mode has reignited this debate.
Regarding the recent rate cut, UK advisory firm Redington noted, “This week saw the Federal Reserve move into interest rate cutting mode again for the first time in 2025, lowering borrowing costs by a quarter point, and signalling further reductions ahead as the labour market weakens. Wednesday’s move marks the first rate cut since December and reflects the Fed’s growing concern that a weakening job market poses a greater immediate threat than the potential for inflationary pressures from tariffs. The adjustment places the federal funds rate at its lowest level in nearly three years, while Fed officials emphasised that further easing remains on the table.”
With more expected, investors are split.
The optimists see the first Fed rate cut as akin to a crack in a dam wall, and a path to significantly lower yields, potentially igniting a stock market rally that could inflate the current bubble even further.
Pessimists, however, point to deeper structural issues: eroding Fed independence, threats to the dollar’s global dominance, and the unresolved ghosts of the 2008 Global Financial Crisis (GFC).
The bull case
The Fed’s long-awaited shift from hiking to cutting rates is seen as opening a floodgate. Bond yields have been artificially propped up by the central bank’s aggressive stance, creating a disconnect from weakening economic fundamentals. Now, with a chink in the dam wall, yields could finally “catch up” to reality, plummeting lower and providing rocket fuel for equities.
The core bullish point is the apparent unresponsiveness of the 10-year Treasury yield to cooling economic metrics. Despite inflation’s sharp decline and slowing growth, yields have remained elevated, largely because the Fed’s rate hikes established a firm floor. Short-term rates were pushed higher to combat inflation, indirectly anchoring long-term yields. But with easing underway, this floor collapses.
Today, CPI, GDP and jobs growth are much lower than they were when bond rates first reached the levels at which they now remain. Bulls see the absence of a corresponding fall in yields as reflecting pent-up potential for them to do just that. As real economic activity continues to weaken – evidenced by labour market softness and decelerating growth – yields should, the bulls argue, logically fall to reflect lower inflation expectations and reduced demand for borrowing.
Historical precedents show that when the Fed pivots to easing after a hiking cycle, long-term yields often follow, sometimes overshooting to the downside. Investors betting on this argue we’re on the cusp of a similar move, potentially pushing the 10-year yield below 3 per cent or even lower. Such a decline would lower borrowing costs across the board, from mortgages to corporate debt, stimulating investment and consumption.
Rate cuts are stock market rocket fuel
Tied to this is the bullish enthusiasm for equities. A wave of rate cuts, many believe, would supercharge the stock market, amplifying the current bubble. Lower yields make bonds less attractive relative to stocks, driving capital into riskier assets. We’ve already seen glimpses of this: Tech-heavy indices have soared on AI hype and easy money expectations, even as broader economic indicators falter.
The bulls also point out the Fed comments paint a picture of a “sound” economy needing only modest tweaks – a quarter-point cut now, with more to come. They believe controlled easing will help avoid a recession while reigniting animal spirits. If yields drop sharply, it could trigger a virtuous cycle: Cheaper financing boosts corporate profits, buybacks, and mergers, further inflating valuations. And if quantitative easing (QE) resumes apace, buckle up!
In essence, the bullish narrative is one of normalisation – another soft landing if you will. The economy’s softening isn’t a harbinger of doom but a manageable slowdown that rate cuts can address. Bond traders, having waited patiently, might now pile into Treasuries, driving yields down and creating a tailwind for risk assets.
The bear case
The bears argue high bond yields aren’t just a Fed-induced artifact; they’re a symptom of deeper, unresolved problems. Rate cuts alone won’t suffice because the real drivers –geopolitical threats, eroding institutional trust, and the GFC’s lingering fallout – remain unaddressed.
The bears contend bond yields could persist at an elevated level, or even worse, spike if confidence erodes further. The more extreme bears suggest the financial system isn’t sound, but as a house of cards, with Fed easing merely kicking the can down the road, again.
Threats: to Fed independence and dollar reserve status
Bears argue bond yields have remained high because global demand for U.S. Treasuries is waning. Threats to the Fed’s independence, particularly from President Trump, have spooked investors. Trump’s appointees, such as newly confirmed Fed Governor Stephen Miran, signal a shift toward politicised monetary policy. And that reminds some investors of Erdogan’s rate cuts in Turkey, despite already elevated rates of inflation, which pushed inflation even further – to 75 per cent in 2022.
Miran’s immediate dissent – favouring a half-point cut over the consensus quarter-point –and his extreme projection of rates dropping to 2.9 per cent by year-end highlight this erosion of faith in the central bank’s independence. Miran also advocates for “creative” tools to lower long-term rates and wholesale Fed reforms. With a new Fed chair expected next year, the bears fear a “rewired”, more interventionist, and less predictable central bank. As Principal and Chief Economist at RSM US LLP, Joe Brusuelas has noted, the “buttoned-down” world of U.S. central banking is being upended [by Trump].
Clearly, politicisation undermines trust. Global investors, already wary, might understandably demand higher yields as a risk premium. Compounding this is the perceived threat to the U.S. dollar’s global reserve currency status. Central banks worldwide now hold more gold than U.S. Treasuries, reflecting diversification away from dollar-denominated assets amid rising geopolitical tensions. If faith in the dollar falters – due to U.S. fiscal profligacy or international rivalries – demand for Treasuries could dry up, keeping yields elevated even as the Fed cuts rates.
Bears argue that bond traders aren’t waiting for rate cuts to buy; they’re waiting for stability that may never come. Gold’s allure as a safe haven highlights this shift, potentially limiting any falls in yields.
The legacy of the GFC
Bears also contend the global financial crisis’ (GFC) core issues were never fixed – they were merely deferred through endless intervention. Global debt has ballooned to US$340 trillion, just as Quantitative Easing (QE), which was sold as a temporary fix in 2008, has become “QE infinity,” with central banks hooked on buying government debt and toxic assets.
Observers note this has birthed a regime of financial repression and permanent bailouts. They argue banks didn’t shrink; they grew larger and more leveraged. Fraudsters weren’t punished; they were appointed to government roles. And the middle class were offered (or perhaps ‘saddled’) with cheap credit, which inflated assets through consecutive “everything bubbles”. Stocks are propped up by debt-fuelled buybacks, bonds yielding less than inflation, fear of missing out (FOMO), private equity, and crypto treasury schemes.
Every shock – 2019 repo panic, 2020 pandemic, 2022 inflation – elicits more liquidity injections, rather than structural reform. We’re not in recovery; we’re in triage – a debt spiral requiring exponential growth to avoid collapse. The bears argue the 2008 fork in the road led us down the coward’s path: papering over losses, socialising risks, and institutionalising crises.
Under this scenario, Fed easing won’t lower yields sustainably because the system is trapped. Higher rates exposed vulnerabilities (like 2022’s inflation breakout), but cuts risk reigniting bubbles without addressing opacity, leverage, or deficits in trust.
Keeping in mind Trump’s family has purchased US$100 million in bonds, yields might dip short-term (he’d win millions) but rebound as investors demand premiums for holding debt in a debased, centralised system. The endgame, the bears reckon, is monetary debasement, social unrest, or authoritarian controls, with savers as collateral damage.
Weighing the scales: a precarious balance ahead
As we stand on the precipice of Trump-imposed Fed cuts, the debate over bond yields encapsulates the broader market anxiety. Bulls see a soft landing where easing realigns yields with fundamentals, boosting stocks and averting recession.
But the bears warn of structural rot – political meddling, dollar erosion, and GFC scars – that could keep yields high.
History’s lessons are mixed. Post-GFC rate cuts saved us from depression and inflated assets, but they also sowed inequality and kicked the can of serious structural repair down the road. Recent rate hikes tamed inflation, but they’ve arguably strained growth.
Perhaps bullish euphoria prevails in the short term, causing the bubble to inflate further, potentially much further. But unresolved problems have a way of resurfacing. We can’t know the future, and that’s why we haven’t suggested liquidating equities. Instead, the prudent course is rebalancing portfolios by reallocating profits from those equities with the most extreme valuations to more conservative or defensive asset classes that still offer reasonable or even attractive returns but without exposure to public markets.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
