Long Rates Hold The Key To Markets

The consensus after Fed Chair Powell’s speech Friday morning at Jackson Hole is that the Fed will cut rates by 25 basis points on September 17. Therefore interest rates are going lower, right?

Not so fast. The Fed controls the Federal Funds Rate which is an overnight rate it sets at which banks can borrow from each to meet their reserve requirements. But the market determines the price of bonds that trade on the exchanges – like the 10 year Treasury – and it is those rates that really matter because they are the benchmark for mortgages, credit cards, corporate loans, etc.. And the key point is this: The longer term rates set by the market can diverge from the short term rate set by the Fed.

For instance, consider what has happened in England over the last year. The Bank of England has cut rates five times from 5.25% to 4.00% but the yield on their 10 year bond has risen over that time period. What is going on?

I believe that investors the world over are becoming increasingly concerned about inflation, deficits and debt. In other words, they are afraid of being paid back with money that has lost purchasing power due to inflation. As a result, they are demanding higher interest rates to hold bonds even if central banks are cutting rates. Rates are rising in Japan and Germany – two of the most important bond markets – as well.

In addition, President Trump seems intent on picking a crony after Powell’s term ends next May and packing the board of governors. He has been all over Powell’s case since returning to office about cutting rates and now he is after Fed Governor Lisa Cook for mortgage fraud because he wants to put one of his own on the board to influence Fed policy. Here’s what Holger Zschaepitz tweeted after Powell’s speech Friday:

Now, the Fed stands at a turning point. Donald Trump is poised to bring it under political curatorship, paving the way for a return to the 1970s; an era of inflation, intervention, and eroded monetary credibility.

With the Federal Debt now over $36 trillion, trillion dollar deficits as far as the eye can see and sticky inflation, it is more than conceivable that long bonds could diverge from the Fed Funds Rate if the Fed cuts in September and even more down the road. In fact, easing monetary policy could exacerbate these concerns in the bond market.

If so, contrary to popular opinion, the interest rates that really matter could be going higher going forward even as the Fed cuts the Federal Funds Rate. Higher interest rates would squeeze economic growth in our heavily indebted global economy and potentially put an end to the bull market in stocks.

Let me be clear: I am not a bear. I am heavily long stocks and real estate. That is the only way to play this game (see “Why You Should Have A Bullish Bias”, May 17, 2025). But there are reasons to be concerned and it would be prudent to keep an eye on long rates for signs of trouble.