UST Curve and FOMC: Mornings After
- The FOMC’s +25 bps hike, with a 12-0 vote, was a credibility builder for the market regarding the current Fed regime and its commitment to fighting inflation. The hike offered more reassurance of the Fed’s independence, coming in the face of Trump foaming at the mouth and threatening to cut off trade if the Fed did not ease.
- Even if one views the Fed vote 12-0 as 24 middle fingers aimed at Trump’s demands for multiple cuts now, the emotions of the moment are less relevant than the economics of the move. The action translates into higher borrowing costs that could squeeze some leveraged credits. The FOMC’s hawkish guidance kept the 2Y UST moving higher in anticipation of another hike before year-end.
- The latest Summary of Economic Projections (“SEP”) report accompanying the FOMC meeting highlights median expectations of 1 more hike by year’s end, with GDP growth expectations ticking slightly higher from the June median to 2.3%. The SEP also highlighted median PCE expectations for 2026 moving higher from June to 3.7%, and Core PCE higher to 3.4%. The median expectation for 2026 fed funds moved to 4.1% from 3.8% in June. Unemployment estimates for 2026 fell from 4.3% to 4.1% (and stayed there through 2028). Relative to the June SEP report estimates from the Fed, the latest release adds up to “higher inflation in 2026, slightly higher GDP growth, notably higher fed funds from 2026 to 2028, and a lower unemployment rate.”
- Mortgage rates ticked higher with the UST curve pushing 10Y UST rates higher. The Mortgage News Daily survey ended the week at 7.2%, while the higher-quality Freddie Mac mix was 6.95% (vs. 6.76% last week), up 69 bps YoY from 6.26%. Back in Sept 2024, the 30Y mortgage was closer to 6.0%.
- It is worth highlighting that the medians show low 2% GDP growth estimates (2.3% in 2026, 2.4% in 2027, 2.2% in 2028, and 2.1% in 2029) that do not merit any “Golden Age” endzone dances or excessive superlatives from Trump. The US is now a 2% annual real GDP growth economy, even if Hassett loves to cite nominal GDP growth as part of his mix of Jedi Mind Tricks.
The chart above shows the ZIRP period during COVID across the tightening and easing cycles. The upward migration of the yield curve shows little sign of abating, with some critical variables and time lags still to work through. The national debt trend line says “more, more, more” while trade war uncertainty, tariff and pricing decisions, and even just what gets Iran and its supporting cast (Houthis, Iraq-based elements) to a cease fire is an impossible call. The “other side” is certainly watching US political dynamics.
Oil price uncertainty and the stubbornness of gasoline, diesel, aviation fuel, and home heating oil will be major factors ahead for households and inflation, whether PPI, CPI, or PCE. The oil speculation scenarios (“oil will spike”, “oil will crash,” etc.) will be constant, but the markets have been schooled lately on how downstream refined product prices can move quickly and painfully based on global supply and demand from the “refined barrel.”
From another angle and on a larger scale, the chart above narrows the migration timeline. We see the rapid rise from Sept 2024 as the easing cycle kicked into gear. The latest move has pushed past the 10Y and 30Y yields out the curve. The worry is that the shift from the front end continues and undermines financing costs for banks and finance companies, and that, in turn, flows into the consumer durables cycle.
The above chart updates another UST curve slope segment. We look at the trend in the 3M-to-5Y UST segment. The most recent slope of +72 bps is below the long-term median of +104 bps with more FOMC hikes ahead. For now, FedWatch shows a 57.6% chance of another hike to 400-425 in Oct with 42.4% chance of no change at +375-400. Looking at the Dec 2026 FOMC meeting, the chances of unchanged fed funds at 375-400 bps are under 10%, while the chances of 400-425 bps are 46.0% and 425-450 bps are 44.1%.
Trump’s threats to “cut off all trade” with partners with large trade deficits if the Fed did not ease monetary policy revealed a lot about his basic grasp of economics. Perhaps creating major shortages of supplies was expected to be a solution to inflation, by creating even more supply-demand imbalances and triggering a fresh round of trade war responses ahead of the holiday season. That would have been interesting. We call that the “Blazing Saddles” defense (think of Mel Brooks’ town sheriff holding his own gun to his own head to blackmail the town rednecks).
For a longer timeline on the 3M to UST, we plot the trends since 1984. The current slope of +72 bps is below the long-term median of +104 bps. We can look back across the highs and lows of the slopes and frame them against the cyclical dynamics and FOMC policies in place at the time.
The inflation X-factor today looms larger than in some of these earlier cycles. Asset quality and systemic risk, as well as economic cycle and dual mandate questions, were more at play, even if inflation was always a high priority for the Fed after the brutal 1970s and 1979-1982 inflation and stagflation (see UST Moves 1978-1982: The Inflation and Stagflation Years 10-18-22).
The lows on the 3M-5Y in the inverted zone usually came late in the cycle or after/during tightening moves (1989, 2000, 2007). The 1989 shift from tightening to easing was a whipsaw as bank system and securities markets trouble surfaced (bridge loans, leveraged lending, etc.).
The UST delta collection… Rates are Rising
The above UST delta chart for YTD shows the bear flattener that has unfolded across the 2Y, 10Y, and 30Y tenors. Clearly, 2026 has been a rough time for bonds and for those who expected lower inflation and lower oil.
The above UST delta updates the post-Iran effect that has caused much of the damage to the bond market, but has yet to do the same to the equity market.
The above UST delta chart is the recurring reminder of where the markets stood before the fateful decision to launch the Iran bombing campaign. The failure to understand what was on the other side of that action (Hormuz, supply shocks, Houthis, and Red Sea) led to the “nuclear weapon replay” after Trump earlier had demanded that everyone agree that such capabilities had already been obliterated. Taking victory laps is standard politics, but it is important that later victories do not deny the earlier celebratory moments.
