The 10-year Treasury yield is climbing after the Fed's big rate cut. Why investors should be concerned.

By Joy Wiltermuth

The Fed's all about delivering a soft landing for the economy. Investors aren't totally convinced.

Benchmark borrowing rates climbed in the wake of the Federal Reserve's big rate cut last week, pointing to a bumpy path ahead as the central bank works to pull off a soft landing for the economy.

In a head-scratcher, Fed Chair Jerome Powell said the central bank cut its policy rate by 50 basis points to help stave off any further weakness in the labor market.

Yet the underlying rate used to finance much of the economy has crept up. If sustained, lower borrower costs could be harder to come by, acting as a potential drag on the economy, lower corporate margins and the risk of layoffs.

"In the end, the relief that the consumer should be feeling from lower rates hasn't happened yet, or at least not to the degree everyone was hoping for," said Philip Blancato, chief market strategist at Osaic, in an interview with MarketWatch.

The 10-year Treasury yield BX:TMUBMUSD10Y, used to finance auto loans, mortgages and companies, briefly climbed to about 3.8% on Tuesday before ending the session near 3.74%.

That's up from a one-year low of 3.62% set on Sept. 16, only two days before the Fed cut interest rates. But it's also almost 1% below its one-year high in April, according to Dow Jones Market Data.

Blancato thinks the market has "unrealistic" expectations for how much relief the Fed will deliver in terms of rate cuts through December, especially if inflation data doesn't cooperate.

His forecast is for the central bank to take a slow and methodical approach after its initial big cut in September, meaning two additional rate cuts of 25 basis points each in November and December.

"That's still a full 1% cut, but it's not a guarantee," he said.

Related: Investors see risks that the inflation battle isn't over yet

Shaken confidence

Powell said the central bank would proceed carefully with rate cuts going forward, and that the central bank expects the unemployment rate to peak at 4.4% next year, or below the long-term average, before easing back to 4.2% over the long run.

That's the soft-landing scenario that Powell has been long talking about.

"For us, this rise in the 10-year rate fits if you believe the Fed's narrative of a soft landing," said Bret Barker, TCW's co-head of global rates.

But Barker isn't in the soft-landing camp. His team still expects the economy to slip into a recession, with the labor market weakening further due to the lag effects of restrictive rates over time. A flight to quality sparked by jitters over the labor market could pull the 10-year Treasury yield as low as 3%, he said.

"There were a lot of lags in the hiking cycle," Barker said. "We expect lags on the way down."

Re-steepening

Longer-term U.S. bond yields took a breather from climbing on Tuesday, following a weak report on consumer confidence for September, even as the shorter 2-year Treasury yield BX:TMUBMUSD02Y ended at its lowest in roughly two years.

The Fed holds sway over short-term Treasury yields because they tend to hinge on the central bank's policy rate. Longer 10-year Treasury yields, however, can fluctuate on changes in market sentiment about the U.S. economy or risk sentiment more broadly.

Yields briefly punched higher in early trade Tuesday after the People's Bank of China cut rates and took other steps to bolster the world's second-largest economy.

George Catrambone, DWS Group head of Americas fixed income and head of trading, attributed the recent moves in bond yields to the "push and pull" in markets over whether the economy is on pace for a soft landing, or already in the early stages of eventually realizing real economic stress.

That tension has been evident as the 10-year yield's push above their shorter 2-year counterparts. The move has sparked a "resteepening" of the Treasury yield curve, after its record run in inverted territory, and rekindled talk of a potential recession.

"But that's because we've had more hard landings than soft landing," Catrambone said of past inversions that resteepened, typically considered the start in earnest to a recession countdown. "That's the question," Catrambone said. "Is this time different?"

While it might take many months for a definitive answer on the economy to emerge, Blancato thinks investors should brace for a tough December, especially if holiday spending disappoints and the Fed delivers fewer rate cuts than expected.

"Stocks are up 20% on the year," he said. "They could give back 5% to 10% if the market doesn't get exactly what it's looking for."

Futures were lower Wednesday after the S&P 500 index SPX closed at a fresh record on Tuesday, up 20.2% on the year so far, according to FactSet. The Nasdaq Composite Index COMP was up 20.4% already in 2024, while the Dow Jones Industrial Average DJIA was 12% higher.

-Joy Wiltermuth

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

09-25-24 0824ET

Copyright (c) 2024 Dow Jones & Company, Inc.