Bond Market Signals a Rate Surge May Be Coming Soon
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3 Takeaways
Monitor long-end yields — A potential breakout in the 30-year rate toward 5 percent or higher could pressure risk assets.
Watch the Fed’s dissent count and the dot plot shift — Increasing dissent or higher dots would imply a less dovish policy path than the market expects.
Track the forward Treasury curve — Rising three-month one-year forward rates may signal that the market is preparing for higher policy rates in 2026, contradicting current easing expectations.
Observations
The bond market is signaling a possible shift toward higher long-end rates, with technical patterns suggesting that 30-year yields could accelerate toward the 5 percent region. Liquidity remains tight despite temporary easing from Treasury paydowns, leaving funding markets sensitive ahead of Wednesday’s Fed meeting. If forward rate structures continue firming, markets may begin pricing in a higher policy-rate path for 2026, challenging expectations for aggressive easing.
Fully Edited Transcript by ChatGPT
This week, we have a Fed meeting on Wednesday, and I want to take some time to review that today. We will also look at some interesting developments in the Treasury rate market involving 30-year and 10-year yields and what’s happening with the Treasury curve. I think it’s important to examine this closely ahead of the meeting. We will also take a quick look at market liquidity and related dynamics. Before we begin, please remember to subscribe to the channel, like the video, share it with your friends, and help support the growth of the channel.
To start the week, I want to point out that last week we saw some paydowns following the large $83 billion Treasury settlement on the first. That helped ease liquidity pressures. Paydowns will continue this week, with another $31 billion on Tuesday, another $7 billion on the eleventh, and then an additional large $80 billion settlement on the fifteenth.
Bitcoin experienced considerable volatility this week. On Monday, prices were down about 4.5 percent, and at one point were even lower. Then on Tuesday, Bitcoin rallied nearly 6 percent, followed by another 2 percent, before falling sharply over the last two days of the week. Much of this appears related to the ebb and flow in the overnight funding market and liquidity conditions. Monday was the large settlement date, and Tuesday saw relief. Now we’re starting to see Bitcoin normalize again. Funding conditions eased somewhat this week, but I would not say they are easy or back to where they should be.
SOFR fell to around 3.92 percent, the lower end of the range. But remember that the effective federal funds rate is around 3.89 percent. SOFR is still trading above effective funds, and ideally, you want SOFR trading below the effective funds rate. Even though SOFR is only three basis points above effective funds, that’s relatively elevated by historical standards and rarely exceeded. Overall, conditions remain tight. They may continue to ease or bottom out this week, and that will be important to monitor. If SOFR cannot get back below 3.90 percent this week, it may struggle to do so for the rest of the year unless the Fed does something significant with its balance sheet on Wednesday—which I am not expecting.
My general view is that liquidity will remain tight. The equity market is moving largely at its own pace. The past two weeks did not unfold as expected from a liquidity standpoint, despite the anticipated drawdowns into the major settlement dates on the 28th and the first. However, we clearly saw the effects in Bitcoin, which is important. Rates spiked, and liquidity gauges declined, even if equities did not fully reflect these pressures. Still, the S&P 500 was down on that Monday session, albeit modestly, which is worth noting. The idea of liquidity-driven weakness is not dead; it just has issues to work through.
More interesting this week is what’s happening with Treasury rates, particularly surrounding the Fed meeting. The 30-year Treasury yield appears to be breaking out of an inverse head-and-shoulders pattern. On Friday, it closed near 4.80 percent, a critical support and resistance level going back to November 2023. If yields move back above 4.80 percent, I think there is a good chance the 30-year rate will head toward 5 percent. Straight-line drops in yields often behave like gaps, so a rapid move toward 5 percent would not surprise me. This week’s Fed meeting provides a backdrop for such a breakout.
Everyone expects the Fed to cut rates at this week’s meeting, and fed funds futures are fully pricing it in. I would be shocked if they didn’t cut. The more interesting question is the number of dissents. In September, there was one dissent from Steven Mirren, who wanted a larger cut. In October, there were two dissents—Schmidt, who did not want to cut, and Mirren, who wanted to cut more. This raises the question: will we see a third or fourth dissent this week?
Laurie Logan has been vocal against further cuts, and Beth Hammack has also expressed reservations. If the list of dissenters grows, that will matter. The dot plot will also be important—not just where policy rates are projected to go, but the shape of the projections. How many members are leaning toward lower rates versus those who aren’t? Are dots shifting up or down, and why? This is not just about where rates will be in 2026; by then, we will have a new Fed Chair, as Powell’s term expires in May. The incoming chair will likely pursue their preferred policy path. What matters now is how difficult the current committee may make it for the next chair to lower policy rates.
Fed minutes from October suggested disagreement surrounding rate cuts, so this meeting could be especially important for assessing sentiment.
Now, looking at December fed funds futures for 2026, they have started to rise. The pattern resembles the 30-year breakout pattern, suggesting a potential move higher. This is unusual, given expectations that the next Fed Chair will favor more aggressive rate cuts. Similar signals are appearing in the three-month and one-month SOFR contracts for 2026.
This may indicate that market views on the future rate path could be shifting—not necessarily shifting yet, but preparing to. The market could be anticipating a policy mistake or an economy that does not justify aggressive rate cuts. It may believe the Fed will ultimately need to push funding rates higher if growth accelerates.
Another data point we haven’t discussed in a long time is the spread between the three-month Treasury bill and the three-month one-year forward rate. This spread has moved sharply higher, unlike fed funds futures and SOFR contracts, which are only beginning to turn. The forward rate is now just 11 or 12 basis points below the spot three-month. This implies the spread is closing. That could be because the spot rate falls toward the forward, or because the forward rises toward the spot.
When merging the spot and forward data, the three-month spot rate is trending downward toward the forward, but the forward rate also appears to be trending higher. This suggests the market may be preparing for three-month Treasury rates to be higher one year from now than they are today. This would require the spread to turn positive, which has happened before—most recently late last year and into early 2024, when markets expected cuts but the forward curve signaled higher future rates. This could be a leading indicator of where fed funds and SOFR contracts may go.
This leads to the broader point: the fed funds market has held firm around 3 percent as the lower bound for the neutral rate. Combined with the breakout in the 30-year yield, the 30-year minus the three-month curve is breaking out of a long consolidation. This aligns with the bear-steepening scenario I’ve discussed for months.
A significant steepening may now be underway. Historically, if the neutral rate is 3 percent, the 30-year yield typically trades about 245 to 250 basis points above fed funds or the three-month Treasury. That would put the 30-year near 5.5 percent. But historically, this is still a low spread. In 2014, when rates were at zero and the Fed was conducting QE, the 30-year traded nearly 400 basis points above the three-month. If we return to that regime, the 30-year could approach 7 percent. That may sound extreme, but historical peaks support that possibility—even if short-term rates fall back to zero.
A longer history using the 10-year minus the three-month spread shows similar behavior. In the 1950s, the peak was around 230 basis points; in the 1970s, more than 300 basis points. The current setup resembles a cup-and-handle pattern breaking out. At 240 basis points, the 10-year would also be near 5.5 percent.
The data shows that long-end rates are potentially headed substantially higher from here. Historically, the current region of the curve corresponds to periods exiting recessions or entering them. The curve is too flat and likely needs to steepen considerably.
Issuance could play a role as well. Treasury indicated at the most recent QRA that it may consider raising coupon issuance several quarters from now, possibly in the second half of 2026. That could further steepen the curve.
I hope you found this helpful. Please subscribe to the channel, share it with your friends, like the video, and continue supporting my efforts to grow on YouTube. Have a great weekend, and we’ll see you again soon.
Defined Terms and Jargon by ChatGPT
SOFR (Secured Overnight Financing Rate): A key benchmark interest rate reflecting overnight borrowing costs collateralized by U.S. Treasuries.
Effective Federal Funds Rate: The weighted average interest rate at which banks lend balances to each other overnight.
Treasury Settlement: The date when buyers of Treasury securities must pay for their purchases, often affecting short-term liquidity.
Paydowns: Principal payments from mortgage-backed securities that return cash to holders, temporarily easing liquidity conditions.
Dot Plot: A chart published by the Fed showing each policymaker’s projections for future interest rates.
Dissent: When a Federal Reserve member votes against the committee’s policy decision.
Fed Funds Futures: Market-traded contracts reflecting expectations for future federal funds rates.
SOFR Futures: Contracts linked to expectations for future SOFR levels, used to infer future funding conditions.
Forward Rate: A market-implied interest rate for a future period, derived from current yields.
Yield Curve Steepening: When the spread between long-term and short-term rates widens, signaling market expectations for stronger growth or higher inflation.
Inverse Head and Shoulders Pattern: A technical analysis formation suggesting a potential bullish reversal—in this case, higher yields.
Neutral Rate: The theoretical interest rate that neither stimulates nor restrains economic activity.
Bear Steepener: A yield-curve steepening driven by rising long-term rates rather than falling short-term rates.
QRA (Quarterly Refunding Announcement): Treasury’s update on future borrowing needs and issuance plans.
Disclaimer
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