Published on 01-15-2025
In a surprising turn of events, the bond market is sending a clear and concerning message to investors and policymakers alike. Douglas Holtz-Eakin, a distinguished fellow at the Daniels School and president of the American Action Forum, recently highlighted a peculiar phenomenon that demands our attention.
According to Torsten Slok, Apollo's chief economist, the Federal Reserve has cut interest rates by 100 basis points since September 2024. However, during the same period, 10-year interest rates have risen by an equal amount. This unusual behavior in long-term rates following the Fed's easing cycle is raising eyebrows among economic experts.
Holtz-Eakin offers two potential explanations for this anomaly. The first suggests that the market anticipates higher future rates, possibly due to increased inflation expectations or the belief that the Fed will need to raise rates to combat inflation. Alternatively, it could signal that bond market vigilantes are finally awakening to the looming threat of massive federal deficits.
The second perspective posits that different investor groups have distinct preferences for short-term and long-term bonds. This view aligns with the idea that investors are demanding higher rates to absorb the tsunami of federal debt. It also hints at a growing skepticism among global investors towards the United States, potentially leading to a shift in investment strategies.
The January 2025 CPI report will add another layer of complexity to the economic picture. As Holtz-Eakin notes, core inflation hovers unchanged at 3.3% over the past six months, despite a significant drop in shelter inflation. “No cause for alarm bells, to be sure, but also no particular impetus for further easing,” wrote Holtz-Eakins on January 13, 2025.
The persistence of core inflation, coupled with the bond market's behavior, presents a challenging scenario for policymakers. Regardless of the underlying cause, Holtz-Eakin emphasizes that this development is undoubtedly bad news for the economy. It serves as a stark warning to the incoming Trump administration, urging them to carefully consider how their plans for tax legislation, deficit reduction and cross-border economic policies will impact this trend.
As we navigate these uncertain economic waters, it's crucial to keep a close eye on bond market movements. They may well be the canary in the coal mine, signaling potential turbulence ahead for the U.S. economy.
