What’s Happening in the Bond Market?

The interest rates on mortgages, credit cards and business loans have shot up in recent months, even as the Federal Reserve has left its key rate unchanged since July. The rapid rise has startled investors and put policymakers in a tough spot.

The focal point has been on the 10-year U.S. Treasury yield, which underpins many other borrowing costs. The 10-year yield has risen a full percentage point in less than three months, briefly pushing above 5 percent for the first time since 2007.

This sharp and unusually large increase, alongside others, has sent shock waves through financial markets, leaving investors puzzled over how long rates can remain at such high levels “before things start to break in a meaningful way,” said Subadra Rajappa, head of U.S. rates strategy at Société Générale.

So what’s going on?

Strong growth and stubborn inflation

Initially, when the Fed first began to fight inflation, it was short-term market rates — like the yield on two-year notes — that rose sharply. Those increases closely tracked the increases in the Fed’s overnight lending rate, which rose from near zero to above 5 percent in about 18 months.

Longer-term rates, like the 10- and 30-year Treasury yields, were less moved because they are influenced by factors that have more to do with the long-term outlook for the economy.

One of the most surprising outcomes of the Fed’s rate-rising campaign, which is intended to rein in inflation by slowing economic growth, has been the resilience of the economy. While shorter-dated rates are linked mostly to what is happening in the economy right now, longer-dated rates take greater account of perceptions of how the economy is likely to perform in the future, and those have been changing.