Bond Market: What Happened to "Higher for Longer"?

Treasury yields have dropped as weak economic data suggests the Federal Reserve may begin cutting the federal funds rate target earlier than previously expected.

After climbing by more than 100 basis points since late summer, Treasury yields plummeted in the early days of November on signs of slowing economic growth and easing inflation pressures. Ten-year Treasury yields dropped from a high of 5.02% to below 4.50% in less than two weeks' time, before rebounding to the 4.60% area. Two-year Treasury yields also declined sharply, with the market now pricing in the potential for the Federal Reserve to start cutting interest rates as early as June 2024, with a total of 100 basis points (or one percentage point) of cuts being priced in by the end of next year. In the middle of October 2023, only 50 basis points of rate cuts were priced in by the end of next year.

Expectations for rate cuts accelerated after the October employment report

There were several catalysts for the bond market rally. Since the summer, a constellation of factors had combined to send yields to cyclical highs. Strong third-quarter gross domestic product (GDP) growth on the back of resilient consumer spending and employment, rising uncertainty about the potential for an end to the Fed's rate-hiking cycle, and worries about increasing issuance of Treasury bonds combined to create a summer surge in yields. Bond market sentiment was heavily bearish.

However, since late October economic data have shown that the preconditions for the Fed to stop hiking interest rates were emerging. The economy is slowing in response to tightening financial conditions, the labor market is loosening, and inflation is heading lower.