Rising bond market yields, and rising average rate of profit, and interest rates

 

               Rising bond market yields

Rising bond yields usually mean markets expect the Fed to keep rates higher for longer or raise them—because investors are pricing in stronger growth, stickier inflation, or more risk. But the “why” behind the move matters.

How to read it:

• Short maturities (especially the 2‑year Treasury): Closest to the Fed’s next few decisions. If the 2‑year yield jumps above the current fed funds rate, the market is leaning toward hikes or a delay in cuts. If it falls below, the market is leaning toward cuts.
• Long maturities (10‑ to 30‑year): Mix of expected future Fed policy, long‑run inflation/growth expectations, and a “term premium.” A rise here can signal higher inflation expectations or simply more supply/risk premium—not necessarily imminent Fed hikes.

Common scenarios behind rising yields and what they imply for the Fed:

• Stronger economic data: Points to tighter labor markets and demand—raises odds of hikes or “higher for longer.”
• Hotter inflation prints or rising inflation expectations: Increases pressure on the Fed to tighten or postpone cuts.
• Higher term premium or heavy Treasury issuance: Financial conditions tighten even without new inflation news; the Fed might not need to hike because markets did some of the tightening already.

Rule of thumb:

• Watch the 2‑year vs. the fed funds rate. 2‑year above fed funds = market expects tighter policy; 2‑year below = easier policy ahead.
• Also watch breakeven inflation (from TIPS). Rising breakevens point more to inflation worries; rising real yields point more to growth/term‑premium forces.

Free‑market takeaway:
Bond yields are real‑time, decentralized price signals. When they rise, they often discipline policy by tightening financial conditions on their own—sometimes reducing the need for additional central‑bank action. The Fed watches these signals and typically reacts to the underlying drivers rather than the move in yields by itself.

In addition:

             The average rate of profit

The “average rate of profit” is a rough proxy for the expected return on business capital. In a free‑market frame, firms invest until the expected marginal return on capital equals the real cost of funds. So, when the average profit rate rises, the natural real interest rate $r^*$ tends to rise; when it falls, $r^*$ tends to fall. Nominal rates then reflect $i \approx r^* + \pi^e$ (Fisher).

How it links, step by step

• Investment condition: Firms expand capex until $\mathbb{E}[r_K] \approx r + \text{risk premium} + \delta$. A higher average profit rate raises $\mathbb{E}[r_K]$, shifts the demand for loanable funds right, and bids up the market‑clearing real rate $r^*$.
• Wicksellian view: If the profit rate (return on capital) exceeds the loan rate, credit and spending expand until the real rate rises toward $r^*$. If it’s below, activity contracts and the real rate falls.
• Transmission to nominal yields: With $i \approx r^* + \pi^e$, a higher profit rate usually lifts nominal yields via a higher $r^*$. If profit strength also raises inflation expectations $\pi^e$, yields rise even more.

What to watch in practice

• ROIC vs. cost of capital: When economy‑wide ROIC runs above the real cost of debt/equity, capex demand tightens the loan market and pushes up real yields; the reverse when ROIC weakens.
• Term structure: Rising profit expectations often steepen the curve (growth/investment demand out the curve), while falling profit expectations flatten it.
• Credit spreads: Strong profits compress spreads (lower perceived default risk). Weak profits widen spreads even if the risk‑free rate is falling.
• Fed implications: The Fed can set the overnight rate, but it cannot repeal $r^*$. If it holds policy below a profit‑driven $r^*$, inflationary pressure and asset “reach‑for‑yield” emerge; hold it above $r^*$, and you get slack and disinflation. Markets arbitrage these gaps via bond yields and credit conditions.

Nuances

• Source of rising profits matters:
  • Productivity/innovation driven: boosts $r^*$ and investment demand—rates up, healthy growth.
  • Temporary market power or one‑off markups: can lift profits without much new investment; rates may rise less, but competition and entry in a laissez‑faire system tend to erode such rents over time.
• Savings side: If higher profits come with large retained earnings, the supply of loanable funds also rises. The net effect on rates depends on which shift (investment demand vs. saving supply) is larger, but historically investment demand is the binding margin in expansions.

Cheat sheet

• Profit rate rising → $r^*$ up → real and usually nominal yields up; spreads narrower; Fed more likely to stay “higher for longer.”
• Profit rate falling → $r^*$ down → real and usually nominal yields down; spreads wider; Fed more inclined to ease.

Finally:

Other things to look for:

Interest rates are the market’s clearing price for intertemporal trade, so anything that shifts the supply of saving or the demand for investment (plus risk/term premia) can move them. A quick, practical checklist:

Inflation and expectations

• Higher expected inflation lifts nominal yields; falling expectations pull them down. Watch CPI/PCE trends, wage growth, and TIPS breakevens (e.g., 5y and 10y).

Real growth and productivity

• Stronger growth/productivity raises the natural real rate and tends to push real yields up; weak growth does the opposite. Look at PMIs/ISM, unit labor costs, and productivity data.

Labor market tightness

• Tighter labor markets support higher wages and stickier inflation, nudging rates up; slack does the reverse. Track payrolls, unemployment rate, and job openings.

Credit conditions and risk appetite

• Wider credit spreads and risk‑off episodes often push Treasury yields down (flight to safety). Tight spreads/risk‑on can lift risk‑free yields via stronger investment demand.

Fiscal stance and Treasury supply

• Bigger deficits and heavier long‑duration issuance usually raise the term premium and long rates; stronger safe‑asset demand (pensions, insurers, foreign reserve managers) can offset this.

Monetary policy path and balance sheet

• Policy rate expectations (SOFR/OIS curves) dominate the front end. QE tends to compress term premia; QT tends to lift them. Liquidity/reserve conditions can matter for money‑market rates.

Global spillovers and FX

• Higher foreign yields or reduced foreign demand for Treasuries can lift US rates; strong dollar episodes can pull inflation expectations down and sometimes temper yields.

Commodities and supply shocks

• Energy or broad commodity spikes raise inflation expectations/term premia; normalization does the opposite.

Demographics and savings behavior

• Aging, precautionary saving, and income distribution affect the global savings pool; more saving pressure lowers real rates, less saving raises them.

Regulation and taxes

• Bank capital/liquidity rules, interest‑deductibility, and other regulatory/tax shifts alter credit supply and the cost of capital, moving market rates.

Market microstructure/technicals

• Mortgage convexity hedging, pension/insurer duration hedging, dealer balance‑sheet constraints, and large rebalancing flows can swing yields short‑term without new macro news.

How to monitor quickly

• Front end: 2‑year Treasury and SOFR/OIS for the expected policy path.
• Inflation vs. real: TIPS 10‑year real yield and 5y5y breakeven to decompose moves.
• Curve shape: 2s10s or 3m10y for growth/recession signals.
• Risk: Investment‑grade/high‑yield spreads for credit conditions.
• Supply/term premium: Treasury auction sizes/mix and term‑premium estimates.

Free‑market takeaway: Interest rates are decentralized price signals balancing scarce capital and time preference. Stronger profit opportunities or tighter resource constraints bid rates up; abundant saving or weaker investment demand bid them down. The Fed can influence the short end, but durable levels are anchored by market forces.