Bond yields: cyclical trends

Capitalist free markets normally experience cyclical recessions and recoveries which affect the trends in bond yields. (Bond yields move opposite to bond prices.)

In a recession, bond yields usually fall and the prices rise. Conversely, during a recovery, bond yields usually rise and prices fall.

The Federal Reserve has meddled heavily in the bond markets by manipulating the fed funds (short-term) rate and also by buying immense quantities of Treasury and mortgage-backed securities, which they are gradually rolling off now.

The pre-2008 historic average real yield of the 10-year Treasury was about 2.5%. Fed repression pushed this to negative after the 2008 financial crisis and the Covid crisis as shown by the TIPS yield.

The Fed has finally allowed the bond market to approach a normal free-market level. The economy is strong as shown by GDP growth.

The financial markets have been betting on the Fed cutting the fed funds rate in March 2024 and predicting 6 cuts in 2024 as opposed to the Fed’s prediction of possibly 3 cuts. But is there any reason to cut?

Why Cut Rates in an Economy This Strong? A Big Question Confronts the Fed.

The central bank is widely expected to lower interest rates this year. But with growth and consumer spending chugging along, explaining it may take some work.
By Jeanna Smialek, The New York Times, Jan. 30, 2024

Why would central bankers lower borrowing costs when the economy is experiencing surprisingly strong growth?

The United States’ economy grew 3.1 percent last year, up from less than 1 percent in 2022 and faster than the average for the five years leading up to the pandemic. Consumer spending in December came in faster than expected. And while hiring has slowed, America still boasts an unemployment rate of just 3.7 percent — a historically low level…

Inflation has been slowing for months. That means that even though rates today are exactly where they were in July, they’ve been getting higher in inflation-adjusted terms — weighing on the economy more and more.

Increasingly steep real rates could squeeze the economy just when it is showing early signs of moderation, and might even risk setting off a recession. Because the Fed wants to slow the economy just enough to cool inflation without slowing it so much that it spurs a downturn, officials want to avoid overdoing it by simply sitting still…

“Neutral” is the rate setting that keeps the economy growing at a healthy pace over time. If interest rates are above neutral, they are expected to weigh on growth. If rates are set below neutral, they are expected to stoke growth… Right now, officials think that the neutral rate is in the neighborhood of 2.5 percent. The Fed funds rate is around 5.4 percent, which is well above neutral even after being adjusted for inflation… [end quote]

The fed funds rate is a short-term rate that does impact some adjustable-rate bonds and preferred stock yields. Longer-term bond yields are impacted by market forces, including Treasury issuance and evidence of a stronger economy. The Treasury yield curve is rising. This is normal as the markets gain confidence in a “soft landing” in 2024.

Corporate bond yields have been fairly steady since the Covid recovery in 2022. They are much higher than the Fed-repressed Covid yields. Refinancing maturing loans will pressure corporate cash flows.

If the Fed continues to roll off its long-term bonds, I expect the longer-term yields to stabilize and not to follow the fed funds rate down when the Fed cuts. That will result in a normal, positive–sloped yield curve. That cyclical bond trend is a positive indicator for the stock market.


I have yet to hear any reasonable explanation for the “20-year anomaly” that we’ve seen persistently for a few years now. Why is there always a slight bump in yield at the 20-year mark? Why isn’t it more smoothly transitioned as you move from 10-year to 30-year?

So far, the only thing I can think of is that insurance companies prefer to buy 30-year treasuries rather than 20-year treasuries and that is enough to perturb the market.

It’s an interesting question.

If GDP good, employment good, inflation good, then is current Fed Funds Rate good?

For inflation, to me, a big part of the slowdown has just been normalizing after Covid supply shocks. I’m sure higher rates are helping to slow inflation, but I place more weight on normalization for the inflation slow down that we have seen so far. Going forward, higher rates could play a bigger role as the other forces normalize.

Beyond inflation, first question that comes to mind is how much of decent economic numbers are driven by government deficit spending? And then how sustainable are these deficits going forward? We’ve (US) been ok for awhile now, but this can be ok until something starts to crack and maybe the dam starts to break and I then worry that won’t be pleasant.

How to prepare for that unpleasantness as an investor? I don’t know. Suggestions welcome.

Would be nice to see some moderate/gradual action on gov deficits with shared burden, but longer we wait to act the more difficult that gradual part becomes.

1 Like

You said a mouthful there, @mostlylong. You are not the only one who is concerned.



Yes. To put it simply, to avoid a recession and/or having to overcorrect by the time they realize a recession is apparent.

This history of the fed is one of inaction and overreaction. Wouldn’t be nice for it to be a little proactive for a change? It was thankfully proactive in 2020 in the midst of Covid. They quickly lowered rates before there was lagging data to support a declared recession because we all knew it was coming. The Fed cut rates twice in March by 1.5%. NBER did not declare a recession for another three months in June. That proactive action likely helped make the recession a lot shorter. NBER in July declared the recession ended in April.

You left off the most important one - it also impacts the Prime Rate - arguably a more significant rate for the health of the economy than preferred stock yields.

The Fed waited too long to act in 2006 and 2007. They again waited too long to act in 2021/2022. I am hopeful they don’t wait too long again.