Interest Rates Are More Complicated Than The Fed And 10-Year Treasury

Forbes

6 days ago

Man carrying heavy stone with growing interest rate symbol increasing debt. 3D. getty
The Wall Street Journal 's editorial board wrote about interest rates this week. They tried to explain that a change by the Federal Reserve in its short-term benchmark federal funds rate on Wednesday wouldn't necessarily improve borrowing costs. They're right to a degree, but the explanation is overly simplified and seems to miss the biggest point: how global markets, not the Fed, are the real force.
Interest rates at all levels are always based on fundamental rates with an additional amount for risk. To understand what rates will be, the question is which reference value is in place and how much is added.
The Journal noted that expectations are for the part of the Fed that sets rates, the Federal Open Market Committee, to keep the federal funds rate at its current 4.25%–4.5%. What the editorial board called a 'rate-cutting spree' last fall that was 'premature' set off a run-up of yields on the 10-year Treasury Note. The response was unusual; historically, the Treasury yield curve has fallen with the federal funds rate.
There was a rebound in unexpected consumer inflation. 'This climb in yields coincided with a rebound in consumer-price inflation that the Fed didn't expect. After flattening through October, the consumer-price index rose 0.3% in November, 0.4% in December, and 0.5% in January. The FOMC hadn't conquered inflation by September as its members had thought.
It is good to remember that, at the time, the Journal 's editorial board admonished the Fed: 'The real risk for the Fed is if it embarks on a monetary easing cycle that stops the current disinflation and causes prices to rise again.' It was a risk; they were right.
'That's critical because the rates that matter most to the economy are longer rates, especially the 10-year Treasury,' they wrote. 'Those are rates that most affect corporate borrowing and consumer mortgages.' The Broader View Of Interest Rates
The federal funds rate and the yield on the 10-year Treasury Note are both critical to interest rates for commercial and consumer needs. But they aren't the only ones.
The federal funds rate range is the set of interest rates that banks charge one another for overnight unsecured loans. The secure overnight financing rate (SOFR) also involves short-term borrowing called repurchase agreements (repo) backed by Treasury securities. SOFR is calculated by ongoing calculations of loan terms, so ultimately controlled by market activity.
Put more formally by the Federal Reserve Bank of New York, 'The SOFR is calculated as a volume-weighted median of transaction-level tri-party repo data collected from the Bank of New York Mellon as well as GCF Repo transaction data and data on bilateral Treasury repo transactions cleared through FICC's DVP service, which are obtained from the U.S. Department of the Treasury's Office of Financial Research (OFR).' The New York Fed publishes the SOFR on its website at about 8:00 a.m. Eastern time.
SOFR is important as a base for adjustable-rate mortgages, private student loans, home equity lines of credit, and many commercial real estate mortgages. While the Fed has indirect influence on it, SOFR is based on market-driven forces.
As for the 10-year Treasury, it is also driven by market forces. The Trump administration has known all along how important the 10-year Treasury is. In February, Treasury Secretary Scott Bessent said in an interview on Fox Business, 'In my talks with [the president], he and I are focused on the 10-year Treasury [yield].' But the administration has tried to convince and nudge the banking industry to invest more in 10-year Treasury Notes. The intent was to increase demand that, in turn, would boost price and push down yields, which move inversely to price.
And then there is the 5-year Treasury, which is important to banks that are lending on properties or uses that will likely try to refinance within three to five years, like may commercial real estate businesses. It also follows market forces. Interest Rate Complexities
Trying to understand how interest rates work and their potential impact on the economy, companies, and individuals is critical to survive financially. What will happen next is impossible to know. As the Journal wrote of Fed monetary policy moves: 'If short rates fall but long rates rise in anticipation of higher inflation, the economic gain Mr. Trump expects won't occur. What the President needs is a Fed that investors believe favors low inflation and a sound and stable dollar. That will yield lower long-bond and mortgage rates over time.'
However, the uncertainty and distrust the administration has created globally is likely a reason the 10-year yield stays up. With tariffs still creating concern about their potential impact on inflation and Trump pushing for faster economic growth (which usually means higher inflation), it also seems unlikely that a broad set of investors will assume low inflation is going to be a direct goal.