ZIRP: No More Zero Interest Rate Penalties! by Greg Faranello, CFA, Head of U.S. Rates

It has been an interesting pocket of time since last week’s FOMC decision of lowering the Federal Funds rate by 50-basis points. In many ways, this has been a counterintuitive cycle. As we emerged from the global financial crisis of 2008, there were a plethora of homes, workers and not enough jobs. It was a decade that ensued of zero interest rate policy, quantitative easing, very stable inflation, and a focus on the demand side of the economy.
Then post-pandemic: Not enough homes and workers yet plenty of jobs. Inflation, much higher rates and balance sheet runoff. Pandemic conditions have subsided but they haven’t disappeared.
10-year Nominal Yields Since 2000. A Declining Trend Bottoming with the Pandemic in 2020
In the days following last week’s FOMC Decision
You would think more questions about the Fed’s rate pathway moving forward. In reality, and when looking at the forward curve, the Secured Overnight Financing Rate over the course of the next year was already priced to the Federal Reserve’s longer-run neutral rate of 2.90% as per their latest Summary of Economic Projections (September 18, 2024). The questions we have fielded from clients were more about the longer end of the US treasury curve, and particularly the UST 10-year.
The Secured Overnight Financing Rate, December 2025. 2.89% versus the FOMC at 2.90%. High Level on this level means lower in rate.
Is the 10-year UST Priced Appropriately?
It is always hard to tell. For an extended period with the Federal Reserve embarked on ZIRP (Zero Interest Rate Policy) and QE (Quantitative Easing) it was impossible to tell. It is a lesson learned we believe, and inflation was the reason. A global pandemic is the catalyst. It always takes a catalyst. The less Fed intervention, the better for balance sheets, risk assets, and the proper allocation of capital over time.
In looking at the United States now: We view the 10-year a function of:
Expected growth over time, Inflation Expectations, and Term Premium.
The Fed’s longer run GDP 1.80%, Market-based 10-year inflation expectation 2.18%, and the Adrian Crump & Moench Term Premium -.14. There are other term premium models.
The math would put the 10-year at 3.84% versus 3.80% which is where we have been gravitating toward. Stating the obvious, these pieces move but we can now make a more proper, if not perfect assessment.
Chair Powell’s 10-year UST: The gearing of the US and now globally requires lower rates. It’s costly. Our US Treasury will require lower rates. They set up on the short end of the US Treasury curve. What are we going to do about this?
Consumers/Jobs:
Rates will come down further: The forward curve doesn’t matter to consumers. Official changes in the Federal Reserve stance matter. The Fed’s coming down quicker than we think. Lags in policy. On the way of higher rates, it rang the bell.
The US Treasury market has done nothing wrong. But we have come a long way with better inflation, slower growth, lower energy prices, and imminent rate cuts in 2024. We are priced for a steady decline over the coming years in the Federal Funds rate. The Fed is still embarked on QT (balance sheet runoff we call it), not QE like some other rate cutting cycles. This is important and we don’t agree.
We’d like to see balance sheet runoff cease. It’s coming. Kicking and screaming.
Chart on UST 10-year below highlighting the period of 2018 through today. If you look at other periods during that time: The steep and sharp nature of the 50-day moving average through the 100/200 day was accompanied by moves of 100 to 150-basis points. 2019, 2020, late 2023, and now. Some QE involved. 2019 and 2020 blended because of the pandemic.
Context: This latest move in 2024 has been a little over 100-basis points but we are also coming off the highest peak in the 12-year period above. The low in yield from the regional bank hiccup in early 2023 comes in 40-basis points from here.
Powell Chair: The beginning point coming out of 2018 and with the mid-cycle adjustment in 2019 began around 3.25%. This is the longest and deepest amount of time spent through the 200-day moving average since 2020.
Chair Powell made a pivot in late 2023. We believe the Federal Reserve was uncomfortable with the rise in term premium late last year with minor change in their policy stance. It was accompanied by a heavy narrative of abundant US Treasury supply. Interestingly, the US Treasury supply story has not changed, and term premium is back negative. It lends to the weaker global economic landscape. There are realities here but not gospel.
10-year term premium highlights the peak in 10-year nominal yields during this cycle in October of 2023.
Considerations Since the FOMC Decision Last Week
We have fielded many questions since the Federal Reserve’s rate decision last week. In general, we have loved the yield curve steepening theme. And we expect more yield curve normalization ahead. Over the past week the curve has been steepening in both bull and bear fashion. The Federal Reserve welcomes the steepening of the yield curve. In bear fashion with higher longer end rates would not be constructive.
Some bullet points on local and bigger picture 10-year pricing:
- We were priced mainly for 50-basis points heading into last week.
- Currently priced to the Fed’s longer run neutral rate by June of 2023.
- The speed matters here. Front-loading interest rate cuts will benefit the short-end and steepen the curve further albeit in a lower rate structure.
- Spot US Treasury yields had already moved a lot since April of this year.
- The Fed is still running off their balance sheet unlike prior cycles.
- Our latest deficit numbers were very poor.
- The election rhetoric is much akin to more spending, both parties.
- Profit taking.
- The Fed’s neutral rate behaves higher. The FOMC has been nudging theirs toward 3% officially. Some members have it higher.
- The UST-year has had a strong correlation to Oil and Inflation Expectations over the past few months. This could cut the other way again as foreign central banks lower rates and China moves aggressively to manage economic fallout.
WTI Crude and UST 10-year nominal yields. Lockstep.
UST 2/10 Yield Curve. A clear breakout to steeper levels and more normalization
Conclusion
In the days following the Federal Reserve’s first rate cut in four years, it has been a message of more interest rates to come, but with a slower cadence. This is consistent with Chair Powell’s press conference. We expect the Fed Chair to reiterate this message on Thursday.
The tempering of jumbo rate cuts moving forward will not be an easy one. With the Federal Reserve firmly in place, any weakness in the economic data going forward, and in particular on the employment side, will be expressed more firmly in the 2–5-year part of the yield curve.
The election in the United States will matter. Not only is the outcome uncertain, but policy equally so. The promises on the campaign trail watered down. The outcome of Congress is important as well. Unknowns should be expressed further out the yield curve.
We view this current move lower in 10-year UST as corrective in nature within a bear market. As Chair Powell intimated during his press conference, it is unlikely we will go back in time (ZIRP). Nothing can be ruled out. We agree. The Federal Reserve and economy would benefit from an even steeper curve with a continued shift lower in rates. With weaker economic data from here, look for the UST 2-year to do the heavy lifting.