Good morning! Markets are closed today in honor of former president Jimmy Carter, who passed away December 29 at age 100.

This morning we’re unpacking red flags in the Treasury market, spiking bond yields, and more. Forwarded this newsletter? Join 190,000 self-directed investors gaining an edge every morning — sign up here.

A shaky economic outlook

Everyone loves talking about the stock market, but the $28 trillion Treasury market is the fortune-teller of the pair — bonds are now flashing warnings of a Fed policy error, resurgent price pressures and a ballooning debt pile.

Even though the Federal Reserve has lowered its benchmark interest rate by 100 basis points since September, the 10-year Treasury yield has climbed roughly 100 basis points in the same stretch. 

We can chalk much of this up to still-strong economic data and rising inflation expectations. 

Specifically: 

Many on Wall Street had expected the Fed’s multiple rate cuts to drag yields lower, not higher, ahead of the new year.

Instead, on Wednesday the yield on the 20-year note touched the rare psychological level of 5%. 

Those on the 10- and 30-year are also trending in that direction, with the former already surpassing its 2024-high in the first week of 2025.

“The 10-year breaching the 5% level would be far more meaningful [than the 20-year], and would represent a break of the October 2023 yield highs, leaving the benchmark treading in waters not seen in years,” said Will Hoffman, senior interest rate strategy associate at Bloomberg Intelligence.

“But the marginal impact on financial conditions is negligible versus trading at 4.99%.”

In December, central bankers pulled back their forecasts for rate cuts, yet Fed Governor Christopher Waller said Wednesday his team could still lower borrowing costs more than expected, so long as inflation falls. 

Markets, for their part, have pulled back their expectations for policy easing.

On Wednesday, CME data showed traders assign a 15% probability that the Fed won’t cut rates this year, up from 4% last month. 

The prediction market Kalshi, meanwhile, currently sees 25% odds of two rate cuts in 2025. 

“Against a backdrop of inflation that remains above the Fed’s policy target and steady — if not accelerating — growth, the case for continued cuts by the Fed becomes tougher to make,” said Jim Baird, chief investment officer for Plante Moran Financial Advisors.

In any case, to DataTrek Research cofounders Nicholas Colas and Jessica Rabe, zooming out provides a less insidious explanation for the bond market. 

Real 10-year yields — that is, adjusted for inflation — have averaged 1.9% over the last 12 months, just below the 2.1% seen from 2003 to 2007, an era when the debt-to-GDP ratio was half of what it is now and economic growth was robust.

“As long as the US economy continues on a firm footing,” Colas and Rabe said, “stocks should be able to take high yields in stride since they are a function of solid growth rather than something more worrisome.”

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Elsewhere:

👀 Fed officials are very concerned. The minutes from policymakers’ December meeting nodded to inflation-related worries over President-elect Trump’s policies. The central bank is inclined to move slower for the time being due to the uncertainty. The minutes included at least four mentions of immigration and trade policy. (CNBC)

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📉 Stocks sank the last time bond yields surged like this. The surge in Treasury yields echoes those of 2022 and 2023, which were both accompanied by a sharp drop in global equities. This time, stocks have only dipped slightly, though to some analysts that simply means more downside to come. (Bloomberg)

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