We are still in the midst of one of the most fascinating bond market periods ever in history—and “ever” is a long time. Just a few years ago, we had grown accustomed to ZIRP (Zero Interest Rate Policy), with rates near zero across maturities, and even negative in large parts of Europe and Asia. Then came 2022, with an inflationary shock not seen since the 1970s, driven by aggressive fiscal spending—cash flowing from the federal government directly to businesses and consumers, all financed by the Federal Reserve printing money. This was a real-world trial of Modern Monetary Theory, though before that term was coined, it was more accurately known as Weimar Treasury Theory. Add supply chain disruptions to the mix, and we saw the most aggressive global interest rate hikes since the Volcker era, leading to the worst bond market returns on record.
After bond investors went through this punishing period, they were left speculating whether the Fed’s policy was too restrictive and when rate cuts might begin. This period saw the longest yield curve inversion in history—from July 2022 to September 2024, lasting 24 months. Holding anything other than cash during this time meant enduring low returns and high volatility. Yet, not holding longer-duration bonds left investors at risk of missing out on a future bond rally that “was bound to happen” someday.
Finally, after two years, during the annual Jackson Hole Economic Symposium this August, where the current “Lords of Finance” (an excellent book by Liaquat Ahamed) meet amidst the scenic Wyoming backdrop, Jerome Powell hinted that it was time to reduce interest rates and focus more exclusively on the labor market. His remarks sparked a ‘bull steepening trade,’ where short-term yields fell faster than long-term yields. The market took this as a signal, and now the forward rate curve projects as many as 10 rate cuts—over 200 basis points—by the end of 2025.
This 200-basis-point figure is particularly noteworthy, as history provides a precedent that suggests it might be on target. In late 2022, I wrote an article for Forbes titled titled “I’m a believer” (The Monkees big hit of 1966-67, written by Neil Diamond)”, outlining the bullish case for equities by drawing on a similar period in 1967, when an inverted yield curve did not lead to a recession. At that time, the Fed Funds Rate dropped from a median of 5.76% in November 1966 to a low of 3.69% in July 1967, a dramatic decline in just nine months—without the help of social media or Bloomberg terminals.
The Fed’s nearly 200-basis-point cut in 1967 did have short-term merit. Real GDP growth on a SAAR basis fell to a low of 0.3% , corporate profits declined by 7.5%, and unemployment rose from 3.6% to 4.0%. These figures pointed to a soft-landing scare, which motivated the Fed to cut rates. However, in hindsight, then-Fed Chair William McChesney Martin admitted upon his retirement in 1970 that he felt he had failed, possibly recognizing that those 1967 cuts had opened Pandora’s box for future inflationary problems.
Today, the market is betting that the Fed Funds Rate will be at 3.00% by this time next year. Unlike in 1966, though, today’s stock market is near all-time highs, corporate profits are strong with nearly 11% growth, and while the labor market may be sending mixed signals, the effects of mass immigration over the last four years on the labor force are unclear. More importantly, the services sector remains robust, household and corporate balance sheets look solid (according to Federal Reserve data), and the Treasury continues its stimulative spending.
So why is the bond market betting on 200 basis points of rate cuts? Are we about to lift the lid on another Pandora’s box? Could the bond market be preparing for yet another U-turn?