From the Desk of AgFi’s Business Strategist Published 10/1/26 – Yesterday, the most important report on inflation, the Personal Consumption Expenditures (PCE) report, was issued by the Bureau of Economic Analysis. It showed that inflation was a bit better than expected but still uncomfortably high. Although inflation was reported to be milder, the 10-year Treasury rate moved higher. What does that mean?
The Federal Reserve (Fed) has historically relied heavily upon the PCE report, excluding food and energy as the primary measure of inflation. Yesterday it was reported that the year-over-year change in the PCE excluding food and energy was 3.0% when it was expected to jump to 3.3%. So, with that good news why would long-term interest rates rise?
It appears that bond market traders are beginning to believe that the Federal Reserve will exert less influence on the direction of interest rates. Therefore, it may be more likely that the relationship of short and long-term rates may be more like the historical norm before the 2008 financial meltdown.
On average since 1958 the Fed funds rate, the rate directly related to Prime Rate, has been about 1.5 percentage points above the PCE excluding food and energy. Over that same period, the 10-year Treasury rate has averaged about 2.5 percentage points above that measure of inflation.
For the period of 1979-2007, the 10-year Treasury rate was at or above that level as the Fed fought to control inflation. During that period the Fed varied the Fed funds rate more often to spur or slow the economy, but the average was greater than the long-term historical average.
Beginning with the financial meltdown in 2008, and continuing since, the Fed has been much more active in influencing interest rates. They pushed the Fed funds rate to near zero and held it below 1% from 2008-2017 and then again from 2020-2022. That long period of very low short-term rates influenced the expectations for future rates and drove long-term rates down. The 10-year Treasury rate is primarily determined by the expectation of the path of future short-term rates.
With Kevin Warsh as the new Fed chairman, it is becoming clear that the Fed will be less active in managing interest rates. Instead, it is likely that the Fed will revert to historical norms and allow the market to establish appropriate rates.
If that is true, then we should expect the Fed funds rate and 10-year Treasury rate to be near historical norms. At the historical norm, the Fed funds rate would be 1.5 percentage points above the PCE excluding food and energy (3.0%) , and the Fed funds rate would be 4.5%. Today, it is 4.0% with the common expectation for an increase to 4.25% or 4.50%.
Using the same relationship to the historical norm, the 10-year Treasury rate would be 2.5 percentage points above the PCE excluding food and energy. That implies a 10-year Treasury rate of 5.5%. Today, the 10-year Treasury rate is 5.30%. If this view of the market is correct, then we should expect interest rates to be higher than in recent years. Most importantly, for farmers, it is likely that long-term interest rates will not drop significantly from current levels unless inflation declines.
If this view of the market is correct, then we should expect interest rates to be higher than in recent years. Most importantly, for farmers, it is likely that long-term interest rates will not drop significantly from current levels unless inflation declines.