In 1994, the Federal Reserve raised interest rates seven times in 12 months — one of the most aggressive tightening cycles in modern history. While short-term rates moved sharply higher, as expected, the 30Y Treasury yield barely budged. The bond market had also already priced in its own view of where inflation, growth, and long-term policy were headed.
Fed Chairman Alan Greenspan famously called the persistence of long rates a conundrum, not because it was inexplicable back then, but because it was a sobering reminder to everyone that although the Fed controls the overnight rate, the market controls the rest.
Today's version of that dynamic is playing out in reverse. The Fed has been cutting its overnight rate since late 2024, slashing 175bp off the federal funds rate in just over 18 months. Yet the 10Y Treasury yield is up more than 50bps over the same period. As of early May 2026, the 10Y was hovering around 4.40%, much higher than many borrowers had anticipated when rate cuts began.
For community financial institutions (CFIs) fielding questions from borrowers, board members, and colleagues, this divergence demands a clear, confident explanation. The good news? The mechanics behind this are very understandable and knowing them is a genuine competitive advantage in all client conversations.
The Fed Controls Only One Rate
The Federal Reserve directly sets the Federal Funds overnight rate, or the rate at which banks lend excess reserves to each other, anchoring the very front end of the yield curve. Instruments like overnight repo, one-month T-bills, and money market funds are highly correlated with the fed funds rate because their maturities are short enough that the policy rate dominates pricing.
Longer-term treasuries, like the 10Y, are a different animal. Those yields reflects what the bond market collectively believes the average short-term rates will be over the stated maturity, with adjustments for the risks of holding long-term debt. Those expectations are shaped by dozens of variables (e.g., inflation forecasts, growth projections, fiscal policy, global capital flows, etc.) that the Fed does not control.
Medium-term treasuries, like the 5Y sits somewhere in between, more responsive to near-term Fed signals than the 10Y, but less anchored to overnight policy than the very front end. The longer the maturity, the more the market (and not the Fed) is in charge.
Fewer Cuts Means Higher Long-Term Yields
When the Fed began cutting rates in late 2024, markets initially priced in an aggressive easing cycle, expecting multiple cuts well into 2025 and 2026. But when economic data came in stronger than expected, and inflation proved stickier than anticipated, investors revised the number of cuts downward and then eliminated them entirely.
When the Federal Reserve began lowering rates in late 2024, market participants anticipated a relatively active easing cycle. Since then, expectations have shifted. The Fed maintained its target range at 3.50–3.75% during its March and April 2026 meetings, and following a higher-than-expected inflation reading, data from CME FedWatch indicates a low probability of rate cuts this year, with some market participants now anticipating no reductions. Persistent inflation, higher oil prices linked to geopolitical developments involving Iran, and the prospect of a Federal Reserve leadership transition have all contributed to the evolving outlook.
This repricing matters for long-term yields. When market expectations change, in this case few overall cuts, longer term yields increase to reflect that new baseline — even if the Fed isn't actively hiking today.
In other words, the bond market isn't reacting to what the Fed did at its last meeting, but rather expressing a view about what policy will look like over the next decade. When those expectations shift, long-term yields shift with them, independent of near-term policy moves.
Investors Demand More Compensation for Long-Term Risk
Beyond rate expectations, a second force is pushing longer-term yields higher: term premiums, or extra yield investors require in order to hold a long-term bond rather than roll over short-term instruments. It compensates for the uncertainty inherent to locking up capital for a longer term (e.g., inflation, fiscal policy, economic growth, etc.) and whether the bond will be worth anything close to face value if sold before maturity.
Between 2010 and 2022, the average term premium was near zero and even went negative during three periods in that timeframe; suppressed by central bank asset purchases, low economic growth projections, and a below target inflation environment. That era is over. According to the St. Louis Fed, the 10Y term premium reached its highest level since 2011 at the start of 2025, surpassing 0.8% and averaging .55% since then. The elevated term premium has been driven by hotter-than-expected inflation prints, stronger economic growth expectations, and increased debt supply.
As MarketMinute noted, fiscal dominance and massive government borrowing are now "a permanent fixture of the market landscape, requiring higher yields to attract buyers for the ever-increasing supply of Treasury debt." Goldman Sachs echoed this view, with its chief economist noting that the U.S. deficit ratio 'would need to be several percentage points lower than it is now in order to stabilize the increase in debt-to-GDP.’ This has pushed real yields higher and kept Treasuries cheaper than they’ve been in a decade.
Inflation, Growth, and Deficits Are Partly to Blame
Treasury yields also embeds the market's collective view on three structural forces: inflation, economic growth, and the US government's borrowing needs.
On inflation, despite the Fed's progress since the 2022-2023 peak, core PCE remains well above the 2% target, and recent data have raised questions about whether further declines in inflation will be as quick and smooth as hoped. To preserve future purchasing power, investors who expect inflation to run at 2.5%-3% over the next decade will demand at least that much in yield from a 10Y bond, keeping rates elevated regardless of what the Fed does overnight.
On economics, Charles Schwab's 2026 fixed-income outlook noted that large and rising fiscal deficits (and the increasing Treasury issuance required to fund them) mean investors must be enticed into buying the long end of the market, putting upward pressure on yields. The Council on Foreign Relations also flagged that tariff-related uncertainty has added another layer of complexity, with the 10Y yield rising by 34bp in just seven days following the Liberation Day tariff announcements as the market recalibrated.
Stronger-than-expected economic activity compounds the macro-economic picture: controlling a robust or “hot” economy suggests the Fed may not need to cut rates and could even be forced to raise them to keep inflation in check, reinforcing the "higher for longer" dynamic at the long end.
Global Investors Also Move the Treasury Market
One final factor that is easy to overlook: the Treasury market is global, and the US doesn't set its own long rates in isolation. Foreign central banks, sovereign wealth funds, insurance companies, and global asset managers are among the largest buyers of US Treasuries. The treasury market, including the 10Y, is essentially a global instrument subject to diverse investor demand far beyond any central bank's control. If overall demand falls, rates rise regardless of what the FOMC does to the Fed Funds rate.
On that note, the Council on Foreign Relations highlighted that one of the longer-term risks to Treasury markets is "questionable foreign demand," particularly if geopolitical tensions or trade policy changes alter the calculus for foreign holders of US debt. Currency hedging costs also matter: when it becomes expensive for a Japanese or European investor to hedge their dollar exposure, US Treasuries look less attractive and yields must rise to compensate.
When global investors are in risk-off mode and seeking safety, they often sell other investments and buy treasuries, that increased demand pushes yields lower. When they're rotating out of treasuries and into equities or other assets (or when geopolitical friction lowers their appetite for US debt), they sell, or buy fewer, treasuries and yields rise.
The Conundrum That’s Not Really a Conundrum
Greenspan's famous 1994 "conundrum" — when long-term rates refused to follow short-term ones — wasn't really a conundrum at all. It was the bond market doing exactly what it's designed to do: look past the present and price in the future.
The same dynamic is playing out today, just in the other direction. The Fed is cutting, but the bond market is looking at inflation that hasn't fully retreated, growing deficits, and a global environment full of uncertainty.
Here are five key takeaways worth keeping in mind for your next client conversation about rates:
- The Fed controls one rate, the market controls the rest: The overnight rate anchors the short end of the curve, while the 10Y reflects what the market thinks the Fed, inflation, and the economy will look like over the next decade. These are two very different conversations.
- Fewer future cuts mean higher long-term yields today: Long-term yields don't just reflect cuts already made, but also what the market believes the Fed will do over a decade, and revised expectations have kept the long end elevated even as the short end falls.
- The term premium has returned: Investors are demanding extra compensation to lock up money for 10 years given uncertainty around inflation, deficits, and long-term policy, a dynamic that pushes the 10Y higher independent of Fed action.
- Inflation, growth, and deficits are structural anchors. Long term yields, like the 5Y and 10Y, can be thought of as a simultaneous vote on long-run inflation expectations, economic growth projections, and confidence (or lack thereof) in US fiscal policy, all three of which are giving investors reason to demand higher yields.
- Global investors move US rates, too. Shifts in foreign demand, risk appetite, and hedging costs move US long-term rates regardless of what the Fed does, another reason long-term yields on the 5Y and 10Y treasuries don’t simply follow moves in domestic monetary policy.
Clients who understand why long-term rates behave the way they do are better equipped to make smarter financing and hedging decisions. And the CFI banker who can explain it clearly, succinctly, without jargon, and without alarm will earn a level of trust that goes well beyond the transaction at hand.
