Many American homebuyers had hoped that the Federal Reserve could make mortgage rates cheaper by cutting interest rates. But so far, mortgage rates have actually risen sharply after the Federal Reserve's "three consecutive cuts".
According to data from Freddie Mac, since the Federal Reserve began cutting interest rates in September, the average 30-year mortgage interest rate in the United States has risen from about 6.1% to about 6.7%. And interest rates are expected to rise further. This is because the mortgage interest rate will change with the yield of the 10-year US treasury bond bond, while the yield of the 10-year US treasury bond bond has risen sharply in the past few months.
In fact, in the eyes of some industry insiders, especially bond market investors, this may be the most "painful" period of the Federal Reserve's easing cycle in decades
Bond traders rarely suffer such significant losses due to the Federal Reserve's loose cycle. And now, they have to worry that there may be more similar situations in 2025.
The most painful Federal Reserve easing cycle in decades
Since the Federal Reserve began lowering benchmark interest rates in September, the yield on 10-year US bonds has risen by over 75 basis points. This is a counterintuitive market reaction - interest rate cuts have actually led to huge losses in the bond market: the 10-year US Treasury yield has now recorded the largest increase in the first three months of the interest rate cut cycle since 1989.
The surge in long-term bond yields is mainly determined by expectations of future short-term interest rates rather than current rates. Over the past three months, although the benchmark interest rate of the Federal Reserve has indeed been declining, expectations for the future direction of interest rates have been on the rise.
Last week, even though the Federal Reserve cut interest rates for the third consecutive meeting, the 10-year Treasury yield surged to a seven month high as policymakers led by Federal Reserve Chairman Powell said they were prepared to significantly slow down the pace of loose monetary policy next year.
Sean Simko, Global Head of Fixed Income Portfolio Management at SEI Investments Co., stated that "US bond yields are being re priced to accommodate higher long-term yields and the concept of a more hawkish Federal Reserve." He believes that this trend will continue, driven by higher long-term yields.
In a sense, the rise in yields also highlights the uniqueness of this economic and monetary cycle.
Despite rising borrowing costs, the resilience demonstrated by the US economy has kept inflation stubbornly above the Fed's 2% target, forcing traders to unwind their bets on further aggressive interest rate cuts next year and extinguishing hopes of a comprehensive rebound in bond prices.
After a whole year of ups and downs, U.S. bond traders may face another disappointing year at the end of the year. The entire treasury bond bond market can only barely keep level with the beginning of the year. The Bloomberg U.S. treasury bond bond index has fallen for the second consecutive week, almost erasing all gains earlier this year, with long-term bonds leading the decline. Since the Federal Reserve began cutting interest rates in September, the index has fallen by about 3.6%.
In contrast, the bond market has achieved positive returns in the first three months of the past six easing cycles.
Will the situation be more difficult next year?
Meanwhile, the outlook for next year will be full of challenges. Bond investors not only face the possibility of the Federal Reserve remaining inactive for a period of time, but also the potential turbulence that the incoming Trump administration may bring.
Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said, "The Federal Reserve has entered a new phase of monetary policy - the pause phase. The longer this continues, the more likely the market is to price both rate hikes and rate cuts equally. The uncertainty of policy will make financial markets more volatile in 2025
At last week's year-end interest rate meeting, in addition to the surprising halving of next year's rate cut forecast to two by the Federal Reserve's dot matrix, there was also a worrying phenomenon - as many as 15 out of 19 Fed officials believed that inflation faced upward risks, while only 3 made the same prediction at the September meeting.
Interest rate market traders quickly readjusted their interest rate expectations as a result. The latest data from the swap market shows that traders have not even fully priced for another interest rate cut in the first half of next year. They are currently betting that the Federal Reserve will only cut interest rates by about 37 basis points next year, which is significantly lower than the 50 basis points predicted by the Federal Reserve's dot matrix.
The recent decline in long-term bonds has not attracted as many bargain hunters as usual.
Morgan Stanley strategists led by Jay Barry have recently advised clients to purchase two-year bonds, but they have stated that they do not "feel the need" to buy longer-term bonds at the moment, citing "a lack of key economic data in the coming weeks, reduced trading volume at the end of the year, and a large influx of new long-term bond supply - the US Treasury Department plans to auction approximately $183 billion in bonds in the coming days.
The only effective strategy left
Of course, luckily, in the current easing cycle of interest rate cut and "interest rate increase disaster", if there is any traditional bond market strategy that can be used for reference, there is still a "unique seed" - betting that the yield curve of US bonds will be steeper, that is, betting that short-term treasury bond bonds sensitive to the Federal Reserve will perform better than long-term treasury bond bonds.
The current environment has created excellent conditions for the steepening strategy of curves. The yield of the US 10-year treasury bond bond was more than 25 basis points higher than that of the two-year treasury bond bond last week, the largest gap since 2022. Last Friday, the spread narrowed after data showed that the Federal Reserve's preferred inflation indicator, the PCE price index, had slowed down last month. But the deal is still the clear winner of the past few months.
It is easy to understand the logic behind this strategy.
Investors are starting to see the so-called short-term value of the curve, as the yield on two-year US Treasury bonds is currently around 4.3%, almost on par with three-month Treasury bills (equivalent to cash). But if the Federal Reserve's interest rate cuts exceed expectations, two-year Treasury bonds will still have a potential price advantage.
From a cross asset perspective, considering the overvaluation of US stocks, two-year US Treasury bonds may also be quite valuable at the moment.
Michael de Pass, Global Head of Interest Rate Trading at Citadel Securities, said, "The market may think that bonds are cheap - of course, relative to stocks - and see them as insurance against the risk of economic slowdown. The question remains, how much do you need to pay for this insurance? And if you look at the forefront now, you don't actually need to pay too much money
In contrast, long-term US Treasury bonds may find it increasingly difficult to attract buyers when inflation remains high and the economy remains strong. Some investors remain wary of Trump's policy agenda, as it may not only fuel economic growth and inflation, but also worsen the already large budget deficit.
Michael Hunstad, Deputy Chief Investment Officer of Northern Trust Asset Management, said that when you start considering the government and spending factors of President elect Trump, this will definitely drive up long-term bond yields. He currently tends to use inflation linked inflation hedging bonds as a "fairly cheap insurance hedge" against rising CPI.