The economic theory suggests that when central banks cut interest rates, bond yields decline. Interest rates are the annual return investors receive from a bond. If the central banks issue new bonds at a lower rates, existing bonds – which yield a relatively higher return – will be received with higher market demand, thereby driving up bond prices. Consequently, their yield, defined as the quotient of interest rate and bond price, falls given the rate cut and higher prices. Yet when the Federal Reserve embarked on lowering rates in September of 2024, the 10-year U.S. Treasury yields have gone against the expectations, rising over 100 basis points to 4.7% – a six month high. This situation has been produced from a mix of economic growth, inflationary pressures, and fiscal challenges, with notable effects stretching beyond just the bond market.
In the previous seven cycles since the 1980s, Key Picture 1 (below) shows that Treasury yields fell 100% of the time within the first 100 days of the first rate cut: Examples include the 2001 downturn, when yields dropped by 120 basis points after three months of the initial cuts, and the 2008 financial crisis, when they fell over 150 basis points while the Fed was aggressively tearing down rates. Normally, during periods of financial uncertainty, such as recessions or financial crises, investors look for stability by purchasing government bonds (as they are considered to be low-risk investments compared to the stock market). This surge in demand pushes bond prices upwards, inversely lowering yields.
However, the market has responded differently this time. Since September 2024, when the Fed started cutting rates, 10-year yields have climbed from 3.6% to 4.7% (over 100 basis points). Unlike past cycles, where slowing growth and reduced inflation lowered yields, today’s economy is showing persistent inflationary pressure, economic growth, and large fiscal imbalances. Quantitative tightening (where central banks reduce the amount of money in the economy’s circular flow by selling government bonds or letting them mature without reinvestment) reduces liquidity in the Treasury market, and a strong U.S. dollar, reflected by its global ‘safe-haven’ reputation, further complicates the traditional relationship between rate cuts and yields.
Key Picture 1: Change in 10-Year Yield Post Fed-Cut
Source: Bloomberg Finance L.P. Data as of January 15th, 2024.
What’s driving the higher yields? One of the main factors is the country’s strong economic growth: Last year, GDP growth doubled initial forecasts to 2.7% – with one of the main reasons being a 10% increase in labour productivity in the last 5 years, partially driven by the $55 annual investment in AI. This significant productivity increase has driven optimism for long-term growth, which in turn is pushing yields higher as investors seem to be anticipating fewer rate cuts in the coming quarters.
Although global inflation has dropped from 10.4% to 4.4% since late 2022, it is still heavily exceeding the Federal Reserve’s 2% target. Backing this up, in December 2024, core consumer prices were reported as rising 0.2% every month, leaving the annual rate at 3.2%. Markets are not convinced that inflation will ease down, incentivising investors to demand higher yields that compensate for future price risks.
The U.S. budget deficit has risen to 6.9% of GDP as a result of increased defence spending, green energy transitions, and many more growing fiscal costs. In an attempt to shrink this gap, the Treasury has issued floods of new debt, which are also requiring higher yields to attract buyers: The foreign demand from traditional buyers like China is also being reduced by increasing geopolitical risks.
The dollar has risen 3.6% since the start of Q4 2024, reaching a 3 year high (Key Picture 2 below). A strong dollar has made Treasuries more expensive for foreign investors – yet another reason for weakening demand and rising yields. In contrast, China is faced with stagnation, with the Yuan facing lows that have not been seen for over a decade; this has resulted in falling yields in the Chinese economy as the bond market is predicting prolonged struggles. Furthermore, the QT (quantitative tightening) program, which reduces bond holdings, has tightened liquidity, effectively further reducing demand. All of these are driving factors that are contrastingly devaluing bonds and pushing yields higher.
Key Picture 2: Five Year Chart of the US Dollar Index
Source: Yahoo Finance, 2025
An obvious implication of these higher yields is increased government borrowing costs, since they result in increased interest expenses. In developed countries with debt-to-GDP ratios over 100%, a mere 1% rise in yields can also add over 1% of GDP in annual interest costs. Relating to this, as borrowing becomes more expensive for the government, lenders are adjusting their own rate to match this, leading to borrowing costs for mortgages and corporate loans rising; this could potentially slow economic activity. U.S. Treasuries are considered a benchmark for risk-free lending, which is why emerging markets will be impacted by higher borrowing costs; they rely on external financing, and investors will seek higher yielding bonds in the U.S. (compared to lower yielding and more volatile markets domestically) resulting in these economies having to up yields by either increasing interest or coupon rates. As a result, they face budgetary challenges.
The country’s robust economic growth, mixed together with inflationary pressures and high levels of debt, has driven the 10-year Treasury yields to defying past trends. For policymakers, the change identifies a need to solve structural challenges, such as working on improving the fiscal deficit. For investors, this is a reminder that previous market expectations do not always continue in such a swiftly evolving global economy.