Monthly Interest Rate Update
Markets are on a wild ride: As trade policy uncertainty deepens, interest rates are swinging sharply. Long-term yields plunged, then spiked 43 bps in a week, while inflation expectations creep higher. The Fed’s next moves? All eyes on May and June.
As equity markets fall, interest rates plunge then spike. While the S&P 500 dropped 15% this year, 10-year Treasury yields followed suit, falling from 4.57% to under 4.0% last week, only to reverse course and climb 43 basis points in less than a week. The long end of the curve has been extremely volatile, with intraday moves of more than 25 basis points. This volatility has been driven, of course, by a high level of uncertainty over trade policy. By pursuing “maximalist” tariffs, the Administration has sowed confusion among our major trading partners, invited retaliation and is making it difficult for business leaders to plan long term capital projects.
Meanwhile, near term inflation expectations have risen. Looking at the TIPS market, investors have priced in an expectation that inflation will be elevated, in the 3.5% to 4.1% range, for the next year. While three-year expectations are more measured, the markets still see annual inflation in the 2.75% rage, well above the Fed’s 2.0% target.
The Federal Reserve will be challenged to effectively manage monetary policy in these conditions. The inflationary (or stagflationary) impact of the tariffs could limit the Fed’s ability to cut rates, as looser monetary policy, along with potential tax cuts, would only fuel more upward pressure on prices. So far, the Fed has avoided any dramatic moves and instead has remained in a wait-and-see mode. Even as long-term yields have swung wildly, the Fed’s short rate benchmark has barely budged this year. This may change as FOMC members have penciled in two more rate cuts this year. Futures traders are now pricing in a 100% probability of at least one rate cut by June, either on May 7 or June 18.
The central bank will also be monitoring market liquidity and fundamental economic data for signs of stress in the economy. On that front, last week’s market turmoil put a damper on the corporate bond market. New issuance was virtually shut down for three days in the wake of tariff announcements. And though one issuer came to market this week, six or seven others elected to postpone pending transactions. In the secondary market, credit spreads have widened as well, especially in the high-yield market, where spreads have jumped from 2.68% to 4.49%.
Policy uncertainty will continue to weigh on the market. Congress still has to address the debt ceiling, which could start to bite as early as next month. And efforts to rein in the Federal budget deficit will be challenging, especially as legislators attempt to extend the 2017 tax cuts.
For the balance of the year, interest rates will be driven by how these shifting policies impact economic fundamentals, and how markets will respond as results of these policies become clearer. With 10-year Treasuries moving in a range between 4.0% and 4.8% this year, and short-term rates likely to fall modestly, there is some visibility into the general shape of the rate environment. However, with such a broad range of outcomes possible, the wild ride is likely to continue for the rest of the year.
Key Statistics: Interest Rates, Unemployment and Inflation
| Year-end 2021 | Year-end 2022 | Year-end 2023 | Year-end 2024 | Mar 31, 2024 | |
|---|---|---|---|---|---|
| 10-yr Treasury yield | 1.51% | 3.87% | 3.88% | 4.57% | 4.20% |
| 2-yr Treasury yield | 0.73% | 4.43% | 4.25% | 4.24% | 3.88% |
| Spread | 0.78% | -0.56% |
-0.37% | 0.33% | 0.32% |
| Fed Funds Target (mid) | 0.125% | 4.375% |
5.375% | 4.375% | 4.375% |
| CME Term SOFR 1-mo | 0.055% | 4.36% | 5.35% | 4.33% | 4.32% |
| CPI (y/y change) | 7.0% | 6.5% | 3.1% | 2.7% | 2.8% |
| Core PCE (monthly) | 4.1% | 4.7% | 3.16% | 2.81% | 2.79% |
| 5-yr TIPS (market breakeven) | 2.91% | 2.38% | 2.15% | 2.39% | 2.38% |
| U-3 Unemployment | 3.9% | 3.5% | 3.7% | 4.2% | 4.2% |
| Real avg weekly earnings | 4.7% | -3.1% | 0.5% | 1.0% | 0.8% |
| Annual change in NFP jobs | +6,451,000 | +4,503,000 | +2,560,000 | +1,450,000 | +1,190,000 |
S&P 500 vs 10-year US Treasury Yield
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Treasury yields had been moving downward alongside the stock market but made a sharp U-turn in the wake of tariff announcements.
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Looking through the volatility, the 10-year yield is only down 15 basis points year-to-date.
Credit Spreads Widen For Both I-Grade And High Yield Bonds
1-Year Inflation Expectations are Elevated
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All rates shown are indications only and subject to change.
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