Since the Federal Reserve's September meeting, 10-year Treasury yields have spiked nearly 60 basis points. This increase reflects multiple forces at play: stronger-than-expected U.S. macroeconomic data (Chart 1), commodity price inflation fueled by Chinese stimulus measures, and recent statements by Fed policymakers advocating a higher terminal rate, as seen with central bank officials Neel Kashkari and Christopher Waller.

Chart 1: Stronger-than-expected macroeconomic data continue to drive rate pressures

Rising political uncertainties add pressure, particularly the increasing probability of a Republican “sweep” (presidency, Senate, and House), that could accompany a potential Trump victory. This political backdrop has fueled market anxieties, as investors brace for the prospect of new tax cuts and potentially a ballooning federal deficit – both factors that historically contribute to upward pressure on bond yields and in particular the Term Premium (Chart 2).

Several key factors are driving the surge in Treasury yields, which we dissect below:

• Revaluation of the terminal rate: A higher terminal rate—essentially the bottom rate expected in the Fed's current rate cut cycle—has been priced in, influenced by data suggesting the U.S. economy remains resilient. A "soft landing" scenario appears increasingly likely, implying a higher "neutral rate" (the rate at which the economy neither accelerates nor decelerates). This revaluation has moved the expected terminal rate from 2.7% to 3.4% within a month (Chart 3), aligning with recent comments from Atlanta Fed President Raphael Bostic, who estimates a neutral rate of 3.0–3.5%.
  

Chart 3: Expected Fed terminal rate, September 16, 2024, vs. today

• Pressure on breakeven rates: Breakeven rates, which represent the difference between nominal and real yields and serve as a proxy for inflation expectations, have been influenced by rising geopolitical tensions and Chinese stimulus. The 10-year breakeven rate jumped from 2.05% to 2.32% over the past month (chart 4), nearing 2024 highs (2.4%). Although oil prices have eased with diminishing risks in the Middle East, breakeven rates remain elevated.

Chart 4: 10-year U.S. breakeven rate vs. Bloomberg Commodity Index

 If the Federal Reserve proceeds with two additional 25-basis-point rate cuts by the end of 2024, as the market anticipates, we could see a yield curve steepening of approximately 70 basis points. This would align with the current 10-year U.S. Treasury yield of around 4.2%, close to the historical average of 80 basis points. Notably, the 10-year U.S. yield has surged by 60 basis points in recent weeks, as markets increasingly expect a Trump victory with a Republican majority across the presidency, Senate, and House. Unlike in 2016—when Trump’s election was a surprise that drove the 10-year yield up by 80 basis points—this time, markets are more prepared, and the adjustments are less abrupt but still impactful.

From a valuation perspective, and given the current economic cycle, a 10-year yield at 4.2% approximates its fair value within a context where a Republican victory is plausible. The recent repricing pressure on the terminal rate seems to be reaching its peak, and breakeven rates have decoupled from oil prices, which have recently softened. This divergence is unusual, as break evens typically mirror movements in commodity prices like oil.