Markets are nervous due to fears that geopolitical tensions and tariffs could stoke inflation and hinder economic growth. This uncertainty is causing sharp swings in U.S. government bond yields, making it challenging for fixed income investors to find stable returns. The Federal Reserve’s response is uncertain, as it monitors the impact of tariffs on inflation before deciding on rate adjustments, adding to market volatility.
Normally, Fed rate cuts lower short-term rates and exert downward pressure on long-term yields. However, in 2025, the combination of stable growth, inflation fears, increased Treasury supply, and quantitative tightening has outweighed this effect. Since September 2024, these dynamics have driven the 10-year yield significantly higher, marking an unusual response to a rate-cutting cycle.
Looking back, one period stands out when the Fed was in cutting mode and Treasury yields rose: 2001-2003 (Post-Dot-Com Bubble): The Fed began easing policy in January 2001, reducing the federal funds rate to 1% from 6.50% by June 2003. The U.S. 10-year Treasury yield started at around 5.10% in January 2001 and ended at about 3.30% in June 2003.
However, within this cycle, there were notable periods when yields rose. March to May 2001: The Fed cut rates twice, yet the 10-year yield increased from approximately 4.80% to 5.40%. October 2001 to March 2002: Despite ongoing interest rate cuts, yields rose to 5.40% from around 4.20%.
Despite the Fed’s latest easing cycle, the U.S. economy has shown resilience, with growth exceeding expectations in 2024. This has led investors to anticipate fewer rate cuts than previously expected, reducing the downward pressure on long-term yields.
Federal Reserve Bank of Atlanta Raphael Bostic said Monday he now expects only one interest rate cut by the end of the year, adding that tariff increases may hinder the central bank’s efforts to lower inflation.
“I moved to one mainly because I think we’re going to see inflation be very bumpy and not move dramatically and in a clear way to the 2% target,” Bostic told Bloomberg Television. “Because that’s being pushed back, I think the appropriate path for policy is also going to have to be pushed back in getting us to that neutral level.”
For CRE investors, higher U.S. Treasury yields mean costlier fixed-rate and variable-rate loans, making projects less attractive and leading them to delay investments. Additionally, higher borrowing costs mean a larger portion of property cash flows goes toward debt service, potentially making projects unfeasible. This is particularly challenging for investors in sectors like office or retail, where cash flows may already be tight. Moreover, higher interest rates affect property valuations by increasing the discount rate used to calculate the present value of future cash flows. This reduces the value of properties, making acquisitions less attractive.
Moreover, the yield curve steepening (100 basis points since last June as measured by the 2s/10s spread) has been a bit of a head-scratcher for investors. You’d think a steeper curve, which is often linked to expectations of economic growth (or inflation), could boost demand for commercial spaces and push up rents or property values, but it’s not quite working out that way – yet.
Even though the yield curve is steepening, other forces seem to be outweighing any potential upside right now such as borrowing costs outpacing gains. If long-term rates are climbing fast (say, due to inflation fears), the cost of financing new projects or refinancing existing loans goes up. For CRE, where leverage is king, this can squeeze returns unless property incomes rise just as quickly—which they often don’t, thanks to long-term leases or market lag.
Additionally, there can be pressure on capitalization rates. Rising long-term rates can push cap rates up, which lowers property valuations unless income jumps. In a steepening environment, if cap rates don’t compress (or shrink) enough to offset higher borrowing costs, CRE investors feel the pinch.
So, while a steepening yield curve might scream “economic optimism” in theory, for CRE investors, it’s more like a mixed bag—or even a bait-and-switch. Higher borrowing costs and shaky valuations can outweigh any rosy growth signals, especially if the market’s still figuring out inflation, interest rates, or tariffs. Some may look for opportunities where rates haven’t fully impacted valuations, but overall, the elevated rates are creating caution.
Heightened concerns about future inflation have also been a significant factor in the price action of government bond yields. Since the Fed’s rate cuts began, inflation expectations—reflected in metrics like 10-year inflation breakeven rates—have jumped.
Potential drivers include proposed tariffs under the Trump administration and expansive fiscal policies, both of which could stoke inflationary pressures. Investors are demanding higher nominal yields to compensate for this anticipated erosion of purchasing power.
Fiscal policy has played a major role, with increased government spending and widening deficits leading to greater issuance of Treasuries. This surge in supply, often referred to as “fiscal largesse,” has put upward pressure on yields, especially as demand hasn’t kept pace. The market is adjusting to absorb this additional debt, contributing to the rise in the 10-year yield.
The Fed’s ongoing quantitative tightening (QT)—allowing Treasuries to mature without reinvesting the proceeds—has reduced demand for long-term bonds. Although the Fed recently tapered QT from $25 billion to $5 billion per month, which could ease some pressure on yields, the broader effect of QT has still contributed to higher yields by shrinking the buyer base for U.S. Treasuries.
Uncertainty surrounding future policies, particularly related to tariffs, fiscal measures, and the Trump administration’s economic agenda, has increased the risk premium investors demand for holding long-term Treasuries. Market participants are betting on yields reaching 5% in the near term, reflecting worries about fiscal deficits and inflation. This sentiment has amplified the upward movement in yields.
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