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Don’t tell the bond market — where Fed Fund Futures contracts imply an 83% probability of a rate cut at the Federal Reserve’s next policy meeting on September 17 — but odds that the Fed will stand pat have just increased. The Labor Department’s report on the Producer Price Index for July showed strengthening inflation pressures at the wholesale level that could show up in the Consumer Price Index soon. Part of the increase appears to be related to tariffs, but part isn’t.
Before this, the 10-year Treasury note’s yield had dipped on August 1, after a weak employment report was released. Concerns about a possibly weakening economy outweighed concerns about soaring government deficits and inflation provoked by tariffs. The 10-year yield will likely stay below 4.5% for a time until more economic data come in that either confirm or dispel fears of an ongoing economic slowdown. The 10-year Treasury is often used as the benchmark for setting mortgage and auto loan rates.
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The new inflationary pressures make it more likely that the Federal Reserve will wait to cut short-term interest rates until closer to the end of 2025. Fed Chair Jerome Powell had just emphasized on July 30 that the Fed wasn’t cutting because inflation is above target and the labor market is still solid. The weak August jobs report undercut the latter half of that narrative, and may have forced him to cut rates in September. But now he can say that the inflationary pressures appear to be a more immediate problem than any potential economic slowdown.
If the next employment report, on September 5, is also weak, then the odds may flip again toward favoring a quarter-point cut at the September meeting. The Fed will also get to see another consumer price report on September 11. These two reports will likely determine whether the Fed acts on September 17 or waits. Powell may also signal in which direction he is leaning during his August 22 speech, at the Jackson Hole symposium on monetary policy, which the Fed sponsors every year.
The yield curve will become upward-sloping sometime next year. The bond market’s concern that there will be an economic slowdown is shown by the fact that current one- to seven-year Treasury notes have lower yields than short-term Treasury bills, which mature in a few months. But 20- and 30-year bond yields have picked up more than the 10-year yield in recent months, indicating that both long-term inflation and government deficits are a rising concern among bond investors. The result is a U-shaped yield curve, with higher short and long yields than medium-term ones. As the uncertainties of tariff policy gradually get resolved, fears of a recession will diminish and medium-term rates are likely to pick up. The long end of the yield curve is likely to stay elevated, however. We expect short rates to fall next year, so the yield curve by the end of 2026 is likely to be consistently upward-sloping along its entire length, for the first time since 2021.
Mortgage rates have dipped slightly this month in response to the decline in the 10-year note’s yield declining. 30-year fixed-rate mortgages are currently around 6.6%, having changed little during the past nine months. 15-year loans are at 5.7% for borrowers with good credit. If the economy weakens more, then rates should also ease further. Mortgage rates are still higher than normal relative to Treasuries, but whenever the Fed cuts short-term rates again, that will boost banks’ lending margins, which should eventually lower mortgage rates a bit, too.
Top-rated corporate bond yields have also been following Treasury yields. AAA-rated long-term corporate bonds are yielding 4.7%, and BBB-rated bonds are at 5.1%. CCC-rated bonds recently bumped up to 12.5% on the weak employment report, but have now eased back to 11.9%. CCC-rated bond rates tend to rise when the risk of recession rises.
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