Just like October of 2023 or April of 2024, there is a lot of confusion over why rates have risen so much. And just like those times, the answer lies in the economic data and their extrapolation. All the other explanations (bond market vigilantes, foreign demand, election) say more about what market participants want it to be about, than what it is about.

So many want credit to become a factor in Treasury bonds to encourage less government spending, but it just isn’t in a material way. The 5-year credit default swap spread for the United States has widened out 7 basis points since the Fed cut 50 basis points, but that is likely because higher rates introduce the idea that debt will be more expensive to service; not the other way around. In other words, rates haven’t risen because U.S. credit risk is higher. The term-premium for 10-year Treasuries has risen in theory, but that can be from the same effect and inflation expectations have risen nearly as much. As you will see below, this yield back-up is concentrated in the belly of the yield curve (3’s, 5’s, and 7’s), not progressively worse out the yield curve like would happen if US credit was in question.

But what is clear from my index below is that economic data has improved consistently and strongly since late July (see gold arrow in chart below.) My daily economic index, which measures the aggregate growth of 45 weekly, monthly, and quarterly economic indicators, brings two important innovations that will be further explained when I complete the latest version of it in coming weeks. In other words, nobody else has this visibility into the growth of aggregate data. Its absence allows the usual suspects (fiscal, foreign demand) to fill the vacuum.

As I think of it, the two primary drivers of Treasury yields are economic data and how far the market thinks the prevailing economic trend will continue—the extrapolation of the data or to put it in stock-market terms, the “multiple” on the economic data. In this business-cycle, because past business cycles have been so consistent in their signals and behavior, the bond market has rushed to price to the historical mold of recessions upon the first signs of weakness. This is heightened now because “it is time” for a recession given what I call “the recession trifecta.” It has been a factor for interest rates all throughout this “top of the business cycle” environment since Silicon Valley Bank went bankrupt in March of 2023. But, when negative economic data hasn’t followed through, bond market yields have risen significantly to reflect a contracting “data multiple.”

What isn’t being appreciated now, is just how big this “multiple” on negative economic data was at the yield lows before the Fed first cut. You can see in the chart above that the 2-year yield fell for a good two months after the economic data started to turn up positively. This period represents the expanding multiple of June’s negative labor data (released in early July) into a full recession as spurred on by Fed Pivot #2 on 7/31/2024. After the Fed’s 50-basis point cut, and because economic data continued to improve, there has been a big, yet appropriate, reversal to back-out all those future expectations. In its simplest terms, a full recession and low-rate aftermath was priced-in that hasn’t come yet.

This can also be seen by where the yield back-up is concentrated on the yield curve in the table below. Yields have risen the most in the 5-year which is about how long the market extrapolated the business cycle effects out to (the lowest rate on the yield curve at the time). If this move had to do with credit, yields at the long-end of the curve would’ve risen the most.

There are 45 basis points of easing priced-in to the bond market over the next two Fed meetings, or a 90% chance the Fed cuts 25 basis points at both meetings before the end of the year. Raphael Bostic, president of the Atlanta Federal Reserve, 2nd biggest district by GDP, has expressed his preference to cut rates at only one of those two meetings. Several other FOMC members sounded hawkish going into the blackout period before next week’s meeting. As things stand, I expect the Fed to cut 25 basis points next Wednesday, but for Powell to give a hawkish-sounding press conference calling a December Fed cut into question which, given the bond market pricing, would cause short-term rates to rise further.

Sometime soon, economic data will turn back around negatively, and the process will repeat, but starting from a lower level than the April yield highs. Nothing is new here, just a Treasury bull market riding the broad waves of economic data and slowly ratcheting down with lower yield highs and lower yield lows in each successive move.