Last September, the Federal Reserve surprised investors.
To kick off the new rate-cutting cycle, the Fed announced an outsized 0.5% rate cut. The typical cut is 0.25%. Larger cuts are usually reserved for economic emergencies.
At the time, Fed Chair Jerome Powell hinted that the large cut held symbolic significance.
The Fed has a reputation for being slow to act. In the past, it has often left rates too high for too long… triggering a recession.
So when asked about the size of the cut, Powell replied that it was a sign of “commitment not to get behind.”
Yet we’re now seeing the unintended consequences of that move…
The Fed’s actions spurred a jump in long-term Treasury yields. In fact, this is the most the 10-year Treasury yield has risen during a Fed rate-cutting cycle in 40 years.
But I’m seeing evidence that Treasury yields have risen too far and too fast… and that could hand us a short-term trade…
The Fastest Rise in 40 Years
The Fed’s job is to balance the labor market with inflation. To do so, the central bank manipulates the short-term interest rates.
Changes in short-term rates can have a big impact on the economy. So those changes often ripple out to long-term rates too.
Long-term rates rise and fall in response to the outlook for the economy and inflation. In particular, economists and investors keep a close watch on the yield for 10-year Treasury bonds.
That brings us back to the Fed’s outsized cut last September…
When the Fed cut rates by a magnitude typically reserved for emergencies, it sent the 10-year Treasury yield soaring higher.
Take a look at the chart below.
The arrow shows the Fed’s first rate cut of this cycle on September 18. The 10-year rate has been surging higher since then.
But a peek at one chart suggests the rise in interest rates this time has gone too far… and could reverse.
And that could hand us a trading opportunity…
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Rates Rising Too Quickly
In the near term, longer-term rates may have gotten ahead of themselves.
Let’s zoom in on the iShares 7-10 Year Treasury Bond ETF (IEF) chart for clues about where rates are heading.
IEF tracks Treasury bonds that mature in 7-10 years. When rates are rising, its price falls – and vice versa. (Bond prices move opposite of yields.)
Now the rise in the 10-year Treasury yield is bringing IEF back to a critical support level.
IEF is testing the $90-91 zone, which has acted as support on two other occasions since the end of 2023.
At the same time, the Relative Strength Index (RSI) has made a higher low (shown with the dashed line). That shows that buying momentum is rising.
Combined, these two clues can be a powerful short-term trading signal. And if 10-year yields are about to take a breather, then IEF’s price could soon rise.
So savvy traders have a shot at capturing that turnaround.
Keep in mind, I don’t expect this pattern to stick around indefinitely…
Looking ahead, inflation seems poised to turn higher. Between strong economic reports and potential policy decisions of the incoming administration, we could see inflation stay elevated for much of 2025.
And inflation fears push bond yields higher, and prices lower.
That means the market may only get a brief reprieve from higher rates. And we may see volatility as the market adjusts.
Yet as traders, that means we will likely see more trades in this space as we head into 2025…
Regards,
Larry Benedict
Editor, Trading With Larry Benedict