Why Long-Term Bond Yields Keep Rising Despite Fed Rate Cuts

Fed policy expert Jim Bianco explains the unusual bond market dynamics challenging traditional monetary policy expectations.

Key Takeaways

• Long-term bond yields have risen over 100 basis points since the Fed began cutting rates in September, defying historical patterns.
• Only comparable precedent occurred in 1981 when Paul Volcker cut rates from 20% to 16% amid similar bond market resistance.
• Markets are pricing inflation expectations closer to 3% rather than the Fed's 2% target, reflecting structural post-COVID economic changes.
• The Fed lacks a working theory of inflation, making their policy guidance less credible to bond markets.
• US economic outperformance stems from greater flexibility and AI innovation compared to Europe's regulatory constraints and China's property crisis.
• Traditional 60/40 portfolios face challenges as stocks and bonds increasingly trade in tandem rather than providing diversification.
• Germany's manufacturing base suffers from lost cheap Russian energy, while China's bond yields plunge to all-time lows signaling economic distress.
• Economic recessions require "murder weapons" - unexpected external shocks rather than gradual economic deterioration.
• Trump's tariff threats likely represent negotiating tactics rather than actual policy implementation, though risks remain.

Timeline Overview

• 00:00–15:00 — Introduction and Jim Bianco's media career evolution from 1980s Wall Street through CNBC and alternative media platforms
• 15:00–30:00 — Fed rate cutting cycle analysis: 50bp + two 25bp cuts totaling 100bp since September, unusual bond market response rising over 100bp
• 30:00–45:00 — International bond market comparisons: UK, German, Japanese yields at multi-year highs while Chinese yields plunge to all-time lows
• 45:00–60:00 — Fed policy mechanics and inflation theory: Dan Tarullo's "no working theory" speech, bond market skepticism of 2% target achievement
• 60:00–75:00 — Structural economic changes post-COVID: remote work adoption, supply chain disruptions, end of 40-year disinflation cycle
• 75:00–90:00 — US economic outperformance drivers: creative destruction, AI innovation leadership, avoiding European energy constraints and Chinese property crisis
• 90:00–105:00 — Portfolio implications and 60/40 strategy challenges, plus premium feed transition for second hour discussion

Bond Market Defies Historical Patterns Amid Fed Easing

The bond market's response to the Federal Reserve's recent rate cutting cycle represents one of the most unusual periods in modern monetary policy history. Since September, when the Fed initiated its easing cycle with an aggressive 50 basis point cut followed by two additional 25 basis point reductions, long-term treasury yields have paradoxically risen by more than 100 basis points. This inverse relationship between Fed policy and long-term rates challenges conventional wisdom about how monetary policy transmits through financial markets.

• Historical analysis reveals only one comparable precedent from 1981, when Paul Volcker reduced the federal funds rate from 20% to 16% while the 10-year treasury yield climbed from 12% to over 15%, demonstrating market skepticism about Fed policy effectiveness during high inflation periods.
• The current 10-year treasury yield has moved from 3.6% in September to approximately 4.8% currently, representing the low point of the year occurring just before the Fed's initial rate cut announcement.
• Market pricing mechanisms now suggest expectations for only one additional rate cut this year, contrasting sharply with Fed officials' public statements indicating multiple future reductions.
• This divergence between market expectations and Fed guidance signals fundamental disagreement about appropriate monetary policy stance given current economic conditions.

International Yield Dynamics Reveal Global Inflation Pressures

Global developed market bond yields are experiencing synchronized increases, suggesting broader inflationary pressures beyond US-specific factors. European markets face particular stress as Germany's manufacturing economy struggles with structural energy cost increases following the disruption of cheap Russian natural gas supplies. Meanwhile, China's bond market tells a different story entirely, with yields plunging to historic lows amid severe economic distress.

• UK gilt markets show similar patterns to US treasuries, with 30-year bonds reaching 28-year highs in yield terms, indicating widespread concerns about persistent inflation across developed economies.
• German economic fundamentals have deteriorated significantly as the loss of cheap Russian energy undermines the country's manufacturing competitiveness, creating a structural headwind for Europe's largest economy.
• The European Central Bank's unified monetary policy prevents Germany from pursuing independent rate policies that might better suit its economic conditions, highlighting constraints of currency union arrangements.
• Chinese bond yields declining to all-time lows reflect economic growth reporting under 5% for only the third time in 50 years, excluding COVID shutdowns and the 1989 Tiananmen Square period.
• Japanese, German, and other developed market yields are reaching multi-decade highs, suggesting global investors are repricing inflation risk across major economies simultaneously.

Fed's Inflation Theory Gap Creates Market Credibility Crisis

Former Fed Governor Dan Tarullo's 2017 observation that "the Fed has no working theory of inflation" continues to undermine central bank credibility as markets question the institution's ability to achieve its stated 2% inflation target. This theoretical gap becomes particularly problematic when the Fed makes public commitments about future inflation outcomes while lacking reliable models to guide policy decisions.

• The Fed's framework relies on various inflation theories including money supply, government spending, rational expectations, and exchange rates, but none demonstrate stable correlations with actual inflation outcomes over time.
• President Biden's May 2022 public directive to Fed Chair Powell to "fix" the 8.6% inflation problem created additional pressure for the Fed to maintain credible commitment to the 2% target despite structural economic changes.
• Core CPI excluding food and energy remained below 3% for 25 consecutive years from 1996 to 2021, but has stayed above 3% for 45 consecutive months since April 2021, indicating a potential regime shift.
• The Fed's upcoming 2025 framework review provides an opportunity to potentially adjust the inflation target to better reflect post-pandemic economic realities, though any changes would require careful communication to maintain credibility.
• Market-based inflation expectations through Treasury Inflation-Protected Securities (TIPS) currently price roughly 2.3% real yields, suggesting investor expectations for inflation closer to 3% rather than the Fed's 2% target.

The Fed's commitment to serving the American people through achieving 2% inflation has become a political promise that may prove impossible to fulfill given structural changes in the post-COVID economy. Like point spreads in football games, market-based inflation expectations provide useful information about directional trends even if they prove imperfect predictors of actual outcomes.

Post-COVID Economic Structure Drives Persistent Inflation

The COVID-19 economic shutdown and restart fundamentally altered the US economy's structure, ending a 40-year cycle of disinflation and creating conditions for persistently higher inflation around 3% rather than the pre-pandemic norm of 2% or lower. These structural changes affect everything from labor markets to supply chains, creating new sources of economic friction that translate into higher prices.

• Remote work adoption across approximately one-third of the economy represents a permanent structural shift, with hybrid arrangements becoming standard rather than exceptional workplace policies.
• The economy's "reboot" following the pandemic shutdown created an fundamentally different system - "an apple versus an orange" - rather than simply returning to pre-2020 conditions as Fed officials frequently claim.
• Supply chain disruptions and changing consumer preferences have created persistent mismatches between production capacity and demand patterns, contributing to ongoing price pressures across various sectors.
• The natural state of capitalist economies involves growth interrupted by unexpected "murder weapon" events like wars, financial crises, or pandemics that force behavioral changes and economic restructuring.
• Historical recession analysis shows that 90% of years since World War II have been expansion years, with contractions requiring external shocks rather than gradual economic deterioration to trigger downturns.

The K-shaped economic recovery has created divergent experiences based on income levels, with lower-income households facing direct inflation impacts while higher-income households benefit from asset price appreciation. This disparity explains why inflation became the dominant political issue during the 2024 election cycle despite economists' focus on declining headline numbers.

US Economic Outperformance Reflects Structural Advantages

America's economic outperformance relative to Europe and Asia stems from superior adaptability, innovation capacity, and absence of the structural constraints limiting other major economies. The combination of flexible labor markets, technological leadership, and energy independence positions the US economy for continued relative strength despite global headwinds.

• The US economy's "creative destruction" capabilities allow faster adaptation to post-pandemic structural changes compared to more regulated European economies that struggle with inflexibility.
• Artificial intelligence development concentrates heavily in Silicon Valley and other US technology centers, with limited meaningful competition from European or Japanese AI initiatives and only copycat efforts from China.
• Energy independence protects the US from the supply disruptions that have devastated German manufacturing following the loss of cheap Russian natural gas supplies.
• China's decades of property market malinvestment have created banking sector problems similar to the US experience in 2008, but Chinese authorities have not implemented comparable resolution measures.
• European regulatory approaches that prioritize compliance over innovation create additional drag on economic adaptation and growth compared to US market-driven solutions.

The Federal Reserve's relative independence from direct political control, despite recent criticism, provides monetary policy flexibility that many other central banks lack due to fiscal dominance or political pressure.

Portfolio Strategy Implications for the New Regime

The traditional 60/40 stock-bond portfolio faces significant challenges in an environment where equities and fixed income increasingly move in tandem rather than providing diversification benefits. Rising long-term interest rates create headwinds for both asset classes while reducing bonds' effectiveness as portfolio hedges during equity market stress.

• The 2022 market experience demonstrated 60/40 portfolio vulnerabilities when both stocks and bonds declined simultaneously, breaking the negative correlation that traditionally provided diversification benefits.
• Current investor positioning shows individuals near retirement holding approximately 80% equity allocations, representing historically high concentration levels that increase portfolio volatility risk.
• Rising mortgage rates create housing market paralysis as homeowners with 3% mortgages avoid transactions that would require new financing at rates above 7%, reducing economic mobility and transaction volumes by roughly one-third.
• Fixed income instruments now offer more attractive risk-adjusted returns with money market funds yielding over 4% and bond funds approaching 6%, providing viable alternatives to equity risk for income-focused investors.
• International sovereign bond markets face synchronized pressure from inflation concerns, limiting geographic diversification benefits that previously helped reduce portfolio volatility.

Assignable mortgage systems used in some European countries could help address US housing market paralysis by allowing borrowers to transfer low-rate mortgages between properties, though implementation faces resistance from mortgage industry participants who benefit from current refinancing and origination fee structures.

The post-pandemic economy fundamentally shifted from four decades of declining inflation and interest rates toward a regime of persistent 3% inflation that challenges traditional portfolio construction assumptions. Bond markets increasingly signal skepticism about central bank abilities to return to pre-2020 economic conditions, while structural changes in work patterns, supply chains, and geopolitical relationships create lasting sources of price pressure. Investors must adapt portfolio strategies to account for reduced diversification benefits between stocks and bonds while recognizing that the US economy's flexibility and innovation advantages provide relative outperformance compared to more constrained global competitors.

• Reassess traditional 60/40 portfolio allocations given reduced diversification benefits when stocks and bonds move together
• Consider higher-yielding fixed income alternatives that now provide attractive risk-adjusted returns above current inflation levels
• Monitor Fed framework review outcomes in 2025 that may formally acknowledge higher sustainable inflation targets
• Evaluate geographic diversification strategies while recognizing synchronized global inflation pressures limit traditional benefits
• Prepare for continued interest rate volatility as markets test central bank credibility regarding inflation control capabilities