A deep dive into the bond market dynamics the Fed can’t control and presidents can’t jawbone away.
KEY TAKEAWAYS
Rate cuts don’t automatically lower long-term borrowing costs
Long-term yields are driven by the term premium and market demand
Deficits and Treasury issuance keep the term premium elevated
The Fed ended QT but is not buying long-duration bonds
Lower long-term rates require fiscal credibility, not Fed jawboning
MY HOT TAKES
Presidents keep pressuring the Fed because it’s politically convenient
The bond market–not Powell, or Hassett… or whomever ends up in the corner office–controls the rates Americans actually pay
The term premium is the single most misunderstood force in markets
Fiscal indiscipline is now the dominant driver of long-end yields
Bond vigilantes are fully back and pricing risk with zero hesitation
You can quote me: “If the President wants lower mortgage rates, he should negotiate with the bond market, not the Fed.”
Paying the price. Do you want the Fed to lower interest rates later this week? Sure, you do. Why wouldn’t you? If you own too many growth stocks–and I know you probably do–you know that the rate cuts increase your chances of continued…er, growth. Growth, in a technical sense, because lower interest rates mean lower cost of capital which increases the present value of future cash flows and thereby increases the theoretical value of your stocks. Growth in a practical sense, because the stock market is simply obsessed–addicted to the sweet taste of lower interest rates. Perhaps, you remember learning in your Freshman year Money and Banking course that lower interest rates allow companies to spend more money cheaply and therefore enable economic growth. I won’t deny that, but I will challenge the notion that a 25 basis-point rate cut will materially impact Apple’s or Alphabet’s ability to grow their earnings or to be as profitable as they have been.
So, yeah, there’s that, but you may also like the idea of lower interest rates because maybe borrowing money will cost less. But will it? That is a resounding YES, for sure. If you want to borrow money for a mortgage, a HELOC (home equity line of credit), or an auto loan, lower interest rates will definitely affect the rates at which you borrow. Well, kind of, and that is the source of lots of controversy. Those interest rates, you see, are tied to longer-maturity Treasury yields like the 10-year Treasury Note. In case you forgot, the Fed controls the Fed Fund’s Rate, which is the overnight lending rate between banks. That gives Fed policy quite a bit of sway over yields that are 3 years and under as well as the prime lending rate, and SOFR which is the benchmark for commercial floating rate borrowing. The 10-year yield is in the hands of the markets. To be clear, there are things that the Fed can do to influence 10-year yields, but its sway is far weaker.
The President has been quite vocal with his desire to have lower interest rates. He has been publicly pressuring the Fed in every way possible–even creating some new ways to turn up the heat. The latest news cycle includes the debate over who the President will nominate to take over for the current Fed Chair. Kevin Hassett seems to be the front-runner at the moment and there is much debate on whether or not he will be able to push the President’s agenda on the Fed. Does he have the cred to head the Fed? Are his bona fides strong enough to influence the FOMC, stacked with academic-banker-economist policy makers? My answer to that is “it doesn’t really matter.” Sure, the Chair is an influential figure, but this is not a Volcker, Greenspan, or even a Yellen Fed. FOMC members are far more vocal and influential today than they have been in the past. It is likely that Hassett will just be another voice–another vote. The Chair’s vote is only 1 of 12, and we have seen a marked increase in dispersion and dissension. So, my answer to the question of influence is no, but that doesn’t mean we are not going to get lower rates. My answer to that is–based on the current economic situation–is yes. But will 10-year yields come down?
By the way, President Trump is not the only president who wants lower interest rates. All US presidents prefer lower interest rates to stimulate economic growth, boost job creation, and improve their political standing, a goal that frequently conflicts with the Federal Reserve’s mandate for long-term price stability. The tension became highly visible when President Truman clashed with the Fed over keeping borrowing costs low to finance the national debt, ultimately resulting in an agreement that cemented the central bank's policy independence. A decade later, a furious President Lyndon B. Johnson famously confronted Fed Chair William McChesney Martin for raising rates to contain inflation caused by his administration's Vietnam spending. During a later recession, President George H.W. Bush privately criticized Fed Chair Alan Greenspan for not cutting rates fast enough, a failure Bush’s team later blamed for his loss of the 1992 election. So, President Trump’s obsession is nothing new… really.
Let’s get back to 10-year yields. The Fed finally pivoted off the brakes last year and began to cut rates. After a pause earlier this year, it is back at it, but 10-year yields refuse to comply with the easing. Check out the following chart, and keep reading.
On this chart you can clearly see how Fed Funds (blue line) started shifting lower in September of last year, and how 10-year yields (white line) shot up at the same time. They peaked earlier this year and have since come down, but not materially. This effect is also present when looking at mortgage rates. Check out this chart and keep reading.
This chart shows Fed Funds declining (blue line) and 30-year fixed mortgage rates rising around ¾ of a percentage point right after the Fed started to cut rates! Ultimately, they came down, but ultimately by only around 30 basis points, net. So what gives?
What gives is something far more inconvenient than the easy narratives served up on television. It is the term premium–that stubborn, often-misunderstood extra yield investors demand for holding long-duration Treasuries instead of short ones. If the Fed controls the front end, the term premium is like that unruly teenager living upstairs who reminds you daily that he does not, in fact, answer to you. 🤣 The term premium is supposed to compensate investors for inflation uncertainty, interest rate uncertainty, geopolitical risk, fiscal risk, and market structure quirks. In academic circles, you will often hear this clean definition: long-term yields equal the expected path of short-term rates plus the term premium. In other words, you can cut overnight rates all day long, but if the people who actually buy your long-term debt are nervous, unimpressed, or simply overwhelmed by the sheer volume of supply, that extra yield can stay elevated. That is exactly what has been happening. It is the missing link that explains why 10-year yields didn’t obediently follow the Fed down like my well-trained Cavapoo puppy Eloise. 🐶
And here is the uncomfortable reality: the term premium is not likely to fall meaningfully in the near term. There are several reasons, none of them mysterious, all of them grounded in the boring basics of supply and demand. Start with the federal deficit, which is running hot enough to make even the most generous bond investors reach for the ice bucket. Oversized and persistent deficits translate directly into massive Treasury issuance. Think of it like this: every single auction is effectively a negotiation between the US government and global capital markets. The more Treasuries you sell, the more you must ensure that investors show up. And investors will show up… but at a price. That price is a higher term premium.
It’s not political. It’s just math–and basic microeconomics–stupid.
Layer on geopolitical tension, trade wars that are putting upward pressure on costs, ongoing Middle East instability, and the simple reality that the United States is projecting a level of structural fiscal looseness not seen outside of wartime… or a pandemic. These forces push investors to demand even more compensation–because uncertainty is expensive. And while it’s true that the Fed is no longer running off its balance sheet, the end of QT does not magically restore the pandemic-era dynamic when the central bank was an enormous, price-insensitive buyer of longer maturity Treasuries and MBSs. Back then, the Fed was gobbling up supply and suppressing the term premium into negative territory. Today, the Fed is merely not selling; it is not actively buying. The private market is still absorbing the heavy issuance on its own, and without that bid from the Fed, the long end remains sensitive to every auction, every deficit projection, every geopolitical flare-up. With abundant supply and no structural buyer stepping in to cap yields, the term premium stays sticky.
This is why mortgage rates barely budged after the Fed pivoted. It’s not that lenders failed to pass through savings. It is that the underlying benchmark–the long-term Treasury curve that anchors mortgage pricing–has been anchored to something heavier than Fed policy: investor skepticism. You can cut the front end to zero and still not move the 30-year mortgage rate if the long end refuses to play along. I realize that sounds almost sacrilegious in a country raised to believe the Fed can control everything with a dot plot, but markets stopped believing in magic years ago. They see deficits. They see issuance calendars that look more like flood warnings than borrowing schedules. They see wars, tariffs, and political brinkmanship. And because they see these things, they demand a higher term premium. Got it? Sure, you do.
That brings us back to the President. He wants lower rates for all the usual reasons–economic growth, cheaper borrowing costs, political benefit. But he is applying pressure in the wrong direction. Lower mortgage rates, lower auto loan rates, lower corporate borrowing costs… those do not come from the Fed Chair’s press conference or the nameplate on his door. They come from convincing the Bond Vigilantes–the big institutional investors who fund our deficits–to accept a lower term premium. And the only way to do that is through fiscal credibility. Policy credibility. A coherent story about future deficits, supply, and long-run discipline. You can bark at Jerome Powell or his successor all you want, but the Chair does not control the term premium. The market does.
If the Administration truly wants lower long-term rates, the target is not the Federal Reserve Boardroom. It’s the bond auction table. Lower long-term borrowing costs will come not from jawboning the Fed into cutting another 25 or even 100 basis points, but from signaling to markets that deficits will not grow unchecked and that the Treasury is not going to drown the system with endless supply. That is how you calm Bond Vigilantes. That is how you coax down the term premium. That is how you get the 10-year yield to ease. In fact, the irony here is almost poetic: if you want lower costs of capital for households and businesses, rate cuts are the least important part of the equation. The heavy lifting must be done on the fiscal side.
So here is where the narrative comes full circle. You want lower rates because you want cheaper borrowing costs. You want to refinance that mortgage or finally upgrade your kitchen or pick up that vacation property you’ve been dreaming of. You want your stock portfolio–packed with usual-suspect growth names–to continue its ascent on the wings of lower discount rates. You want all the benefits that come with easing. And guess what? You are going to get lower rates from the Fed. The economic data supports it, and the committee has signaled as much. But the rates you care about–the mortgage rate, the auto loan rate, the business lending rate–will not meaningfully come down unless the term premium breaks.
And the term premium will not break because the Fed told it to. It will break when the bond market believes that the long-run fiscal trajectory of the United States is stable enough to warrant lower compensation for risk. It will break when supply expectations improve. It will break when the people buying trillions of dollars of US debt stop demanding a surcharge for uncertainty. Until then, rate cuts alone are like giving someone an umbrella in a hurricane: nice gesture, wrong problem.
So, yes, cheer for lower rates. Cheer for the Fed to do its part. But if you really want the borrowing costs that matter to you to fall meaningfully, you need the President to stop lecturing the central bank and start negotiating with the bond market. The vigilantes are wide awake, and they are the ones setting the price. 😉
FRIDAY’S MARKETS
Stocks gained in Friday’s session on a fairly tame PCE inflation report that showed a modest increase in inflation… in September… when leaves were still on trees. 🤣 University of Michigan reported that consumer sentiment picked up last month after tanking in the month prior. Bitcoin resumed its decline on Friday keeping it below a key support level.
NEXT UP
No economic numbers scheduled for today, but there is always the chance that we may get some delayed ones from the shutdown.
Later this week we will still get some important earnings as well as JOLTS Job Openings, Initial Jobless Claims, and some housing numbers. The main act of this week’s calendar, however, is the Fed’s FOMC meeting which will wrap up on Wednesday and be followed by a Press Conference and everyone's favorite DOTPLOT! Check out the attached earnings and economic calendar so you can feel like you are in charge of your financial well-being–go
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