The 10-year Treasury yield is rising after the Fed’s big rate cut. Why investors should be worried.

Benchmark lending rates rose following last week’s big rate cut by the Federal Reserve, pointing to a bumpy road ahead as the central bank works to achieve a soft landing for the economy.

In a head-scratcher, Fed Chairman Jerome Powell said the central bank cut its policy rate by 50 basis points to help stave off any further weakness in the labor market.

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However, the base rate used to finance much of the economy has risen. If sustained, lower borrower costs could be harder to come by, acting as a potential drag on the economy, lower corporate margins and the risk of layoffs.

“Ultimately, the relief that the consumer should feel from lower rates hasn’t happened yet, or at least not to the extent that everyone was hoping for,” said Philip Blancato, chief market strategist at Osaic, in an interview with MarketWatch. .

The yield on the 10-year Treasury BX:TUBMUSD10Y , used to finance auto, mortgage and corporate loans, briefly rose to around 3.8% on Tuesday before ending the session near 3.74%.

That’s up from a one-year low of 3.62% set on Sept. 16, just two days before the Fed cut interest rates. But it’s also nearly 1 percent below a one-year high since April, according to Dow Jones Market Data.

Blancato believes the market has “unrealistic” expectations for how much relief the Fed will provide in terms of rate cuts through December, especially if inflation data doesn’t cooperate.

His forecast is for the central bank to take a slow and methodical approach after its initial big cut in September, meaning two further rate cuts of 25 basis points each in November and December.

“That’s still a full 1 percent reduction, but it’s not a guarantee,” he said.

Related: Investors see risks that the inflation battle is far from over

Confidence shaken

Powell said the central bank would proceed cautiously with rate cuts going forward and that the central bank expected the unemployment rate to reach 4.4 percent next year, or below its long-term average, before falling back to 4. 2% long term.

The story continues

This is the soft landing scenario Powell has been talking about for a long time.

“For us, this hike in the 10-year rate fits if you believe the Fed’s narrative of a soft landing,” said Bret Barker, TCW’s co-head of global rates.

But Barker is not in the soft landing camp. His team still expects the economy to enter a recession, with the labor market weakening further due to the lagged effects of restrictive rates over time. A run to quality triggered by jitters over the labor market could push the 10-year Treasury yield down to 3 percent, he said.

“There were a lot of delays in the hiking cycle,” Barker said. “We expect delays on the way down.”

Re-clogging

Longer-term U.S. bond yields took a break from gains on Tuesday following a weak consumer confidence report for September, even as the shorter 2-year Treasury yield BX:TUBMUSD02Y ended at its lowest in about two years.

The Fed holds sway over short-term Treasury yields because they tend to be based on the central bank’s policy rate. However, longer-term 10-year Treasury yields can fluctuate based on changes in market sentiment about the U.S. economy or overall risk sentiment.

Yields rose briefly in early trading on Tuesday after the People’s Bank of China cut interest rates and took other steps to support the world’s second-largest economy.

George Catrambone, head of Americas fixed income and head of trading at DWS Group, attributed the recent movements in bond yields to the “push and pull” of the markets, whether the economy is on pace for a soft landing or already in the early stages of realizing in the the latter a real economic stress.

This tension has been evident as the 10-year yield pushes above its shorter 2-year counterparts. The move sparked a “re-tightening” of the Treasury yield curve, after entering inverted territory, and reignited talk of a potential recession.

“But that’s because we’ve had more hard landings than soft landings,” Catrambone said of earlier reversals that intensified, usually seen as the serious start to a recession countdown. “That’s the question,” Catrambone said. “Is this time different?”

While it could take many months for a definitive response on the economy to emerge, Blancato believes investors should brace for a difficult December, especially if holiday spending disappoints and the Fed offers fewer rate cuts than expected.

“The stock is up 20% a year,” he said. “It could give back 5% to 10% if the market doesn’t get exactly what it’s looking for.”

Futures were lower on Wednesday after the S&P 500 SPX index closed at a new record on Tuesday, up 20.2% year-to-date, according to FactSet. The Nasdaq COMP is up 20.4% already in 2024, while the Dow Jones Industrial Average DJIA is up 12%.

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