by StatisticalMan
Long bonds are not based solely on the current fed funds rate. They are based on projected short term rates over the duration of the long bond.
They have a yield at a premium to short term rates due to the risk/lockup but not just the current short term rate that exists right now. They are based on a projected short term rates over the period of the bond. Lets say the duration premium is 1%. So the 5% yield on a 10 year bond is an assumption that short term rates will average 4% over the period of the bond. It might be 6% right now, 5.5% next year, eventually 4% and years from now <3% but it averages 4% in this example. It won’t be priced below that the expected short term rates over that period. If you thought short term rates will average 5% over the next five years but 5 year bond was trading at 3.95% there would be no reason to buy the 5 year bond you would just buy 6 month treasuries and roll it over 10 times instead of a 5 year bond.
Make sense so far?
Ok so long bond rates can go up if the expectation of average higher rates OVER THE PERIOD OF the bond increases. That can happen even if current short term rates are paused or even declining. What could do that? Well an acceptance that it will take the fed longer to taper rates is probably the dominant impact right now. Yes even the Fed lowering rates can make long bonds rise in yield.
Many investors now believe that while the Fed will get and keep inflation under control it may require higher than previously expected short term rates and more importantly those elevated rates will last longer. The taper may be more gradual and take longer. Both factors raise the average short term rate over the next 5, 10, 20 years. Long bonds would trade at a premium to that expected average so bonds yields at the far end of the curve are rising.
It is important to understand the fed funds rate is nothing but overnight lending rate between banks. Directly other than QE that is all the control the Fed has. However since mony flows to the best yield t influences other rates because all debt competes for the same money. It isn’t however a 1:1 ratio it isn’t even necessarily in the same direction.
Hypothetically say six months from now the Fed cuts rates by 0.25%. Long bonds yields go down right? Not necessarily long bonds yield may go higher if the cut took longer and was smaller than investors expected. If investors were expecting a 0.5% drop in April and Fed hiting at another 0.5% drop in May and instead got a 0.25% drop in April and hint that it may be 2-3 months before there is another drop long bond rates could spike higher. It would be a further confirmation that short term rates will remain elevated for longer which means long bonds should be priced at a premium to that. The more the Fed has to slow down rate cuts the more long bonds yield could go up because the expectation on what the average short term rate over the next 5, 10, 20 years will be is rising.