Understanding the Yield Paradox: Why Bond Yields Rose Despite a Fed Cut

As 2025 comes to a close, one of the defining stories for financial markets may have been the complete breakdown of the traditional relationship between Federal Reserve policy and Treasury yields. The Fed began lowering interest rates in September 2024, a cycle that continued throughout 2025. While past performance does not guarantee future results, it is worth noting that yields have historically tracked this path lower. However, this time around, they didn't.

The 10-year Treasury yield began at 3.63% during the easing cycle before reaching 4.15% in late 2025, when the Fed initiated its policy.This pattern broke a four-decade historical precedent. J.P. Morgan research first flagged this anomaly in early 2025, noting that in the previous seven cutting cycles going back to the 1980s, the yield on the 10-year Treasury was lower 100% of the time 100 days after the first cut. 

Looking back to December 2025, it has officially become the first "rebel" cycle in 40 years.

TL;DR

• Historic divergence: The 10-year Treasury yield has increased by more than 100 basis points since the Federal Reserve started reducing interest rates in September 2024

• Breaking a 40-year pattern: In the previous seven cutting cycles since the 1980s, yields fell 100% of the time within 100 days of the first cut

• Key drivers: GDP growth exceeded expectations, while inflation rates exceeded target levels, and Federal Reserve members disagreed about monetary policy

• Portfolio implications: Positive equities-bond correlations may reduce traditional diversification benefits for multi-asset traders

What's Driving This Unusual Movement?

Several factors may explain why yields have diverged from Fed policy over the past 15 months.

• Economic resilience: The U.S. economy demonstrated stronger performance than expected as Q3 2025 GDP growth reached 4.3% surpassing the projected 3.3% growth rate. The strong economic data could indicate that the economy does not need aggressive monetary policy action, which has led bond markets to reduce their expectations about future interest rate reductions. Fed policymakers' median projection now points to only one rate reduction in 2026.

• Inflation persistence: Attempts to lower inflation have yielded varying results at each stage of the process. The Federal Reserve uses core PCE as its main indicator, which showed 2.8% inflation during September 2025 while exceeding the desired 2% target. The TIPS (Treasury Inflation-Protected Securities) breakeven spread suggests that market participants anticipate inflation to exceed the Federal Reserve's target rate at this time. (Source: CNBC)

• Policy uncertainty: At their December 2025 meeting, Fed members produced their largest dissent since September 2019, disagreeing about the pace of rate reductions due to varying interpretations of economic data.

The Mechanics Behind the Divergence

To understand why yields moved contrary to Fed policy, it would be helpful to decompose the Total Nominal Yield into its three fundamental pillars. The Federal Funds Rate controls the short-term segment of the yield curve, but the 10-year yield depends on investor predictions about future market conditions.

• Rising Inflation Expectations: The 10-year TIPS breakeven rate, which shows market predictions for future inflation rates, rose from 2.03% during September 2024 to 2.40% when 2025 began. The market shows a 37-basis-point increase, which indicates that price pressures will continue even though the Fed has reduced interest rates.

• Elevated Real Yields: At 2.15%, the 10-year TIPS Real Yield (the return after inflation) is significantly higher than its post-1998 average of 1.33%. The data show that actual borrowing expenses continue to stay elevated, which makes the Federal Reserve's tightening efforts unnecessary.

• The Return of the Term Premium: For years, the "safety tax" investors demanded to hold long-term debt was near zero. Now, it has turned positive. Traders are demanding higher yields to compensate for the uncertainty of the Fed's 2026 path and the heavy supply of new Treasury bonds.

What Fed Officials Have Said

Federal Reserve officials have addressed this unusual yield behaviour directly, though with notably divided views.

• Following the December 2025 rate cut, Fed Chair Jerome Powell said "I think we're in a good place to wait and see how the economy evolves." On rising long-term yields, Powell stated: "When the long bonds move around, you've got to look at why they're moving around... inflation compensation break-evens... they're at very comfortable levels... at levels consistent with 2 percent inflation over time."

• Cleveland Fed President Beth Hammack supports a reserved monetary policy, as evidenced by her votes against interest rate reductions, and believes interest rates should remain at their current levels for several months. She maintains that inflation problems should receive greater attention than the current employment market conditions.

• National Economic Council Director Kevin Hassett (a leading contender to succeed Powell as Fed chair) offered a contrasting view, telling CNBC the Fed remains "way behind the curve" on rate cuts compared with other countries' central banks.

The three dissenting votes from December 2025 indicate that policymakers continue to doubt which interest rate path will occur during 2026.

Strategic Implications: Changes in Bond Market Hedging Dynamics

The bond market now operates with different risk management methods since yields no longer follow their previous patterns. The Federal Reserve has used rate reductions to create stability in bond investments, which increase in value when stock markets experience market fluctuations.

That relationship has inverted: The asset classes now exist in a correlated position. The stock market and bond market maintain a positive correlation since  both have increased together due to solid economic expansion and persistent inflation rates. A multi-asset trader may want to understand that their “protective” side of the investment strategy may generate additional losses when markets experience declines.

Conclusion

The current yield environment has shifted away from the traditional market behaviour that has existed for the last several decades. Whether this signals sustained economic strength or growing uncertainty about policy effectiveness remains to be seen. Understanding these dynamics may enable traders to determine how various financial instruments interact with each other.

*Past performance does not reflect future results. The above is for marketing and general informational purposes only, and are only projections and should not be taken as investment research, investment advice or a personal recommendation.