# **Rate Swings Causing Angst Among Investors**
Markets are on edge as fears of geopolitical tensions and tariffs threaten to stoke inflation and slow economic growth. This uncertainty has led to sharp fluctuations in U.S. government bond yields, making it difficult for fixed income investors to find stable returns. Meanwhile, the Federal Reserve remains cautious, closely monitoring the impact of tariffs on inflation before making decisions on interest rate adjustments, further contributing to market volatility.
### **An Unusual Response to Fed Rate Cuts**
Typically, Federal Reserve rate cuts lower short-term rates and exert downward pressure on long-term yields. However, in 2025, the combination of stable economic growth, inflation concerns, increased Treasury supply, and ongoing quantitative tightening has countered this effect. Since September 2024, these factors have driven the 10-year Treasury yield significantly higher—an unusual response in a rate-cutting cycle.
A similar trend was observed from 2001 to 2003, following the dot-com bubble. During this period, the Fed reduced the federal funds rate from 6.50% to 1% between January 2001 and June 2003. While the U.S. 10-year Treasury yield declined from 5.10% to 3.30% over that span, there were notable periods when yields temporarily rose, such as March–May 2001 and October 2001–March 2002, despite ongoing rate cuts.
### **Stronger Economic Growth and Adjusted Rate Expectations**
Despite the Fed’s easing cycle, the U.S. economy has displayed remarkable resilience, surpassing growth expectations in 2024. As a result, investors now anticipate fewer rate cuts than initially expected, which has reduced downward pressure on long-term yields.
Atlanta Federal Reserve President Raphael Bostic recently stated that he expects just one interest rate cut by the end of the year. He also warned that tariff increases might hinder the Fed’s efforts to control 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.
### **Impact on Commercial Real Estate (CRE) Investors**
For commercial real estate (CRE) investors, rising Treasury yields translate into higher costs for both fixed-rate and variable-rate loans, making projects less appealing and often causing delays in investment decisions. Increased borrowing costs also mean a larger share of property cash flows must go toward debt service, which can make certain projects financially unfeasible. This is especially true for sectors like office and retail, where cash flows are already stretched thin.
Additionally, higher interest rates negatively impact property valuations by raising the discount rate used to calculate the present value of future cash flows. This, in turn, makes acquisitions less attractive.
### **The Steepening Yield Curve and Its Mixed Signals**
The yield curve steepening—measured by the 2s/10s spread, which has widened by 100 basis points since June—has puzzled investors. Traditionally, a steeper yield curve signals expectations of economic growth or inflation, which could theoretically boost demand for commercial spaces and drive up rents or property values. However, this effect has yet to materialize in a meaningful way.
One reason is that rising long-term rates are driving up financing costs faster than property values are increasing. For CRE investors, who typically rely on leverage, this can squeeze returns unless property incomes rise at the same pace. Unfortunately, factors like long-term leases and market lags often prevent rent growth from keeping up with rising borrowing costs.
Another pressure point is capitalized rates (cap rates). When long-term interest rates rise, cap rates typically increase as well, which erodes property valuations unless rental incomes rise significantly. In the current environment, cap rate compression is not offsetting higher financing costs, putting further strain on CRE investors.
### **Inflation Expectations and the Role of Fiscal Policy**
Concerns over future inflation remain a major driver of government bond yields. Since the Fed started cutting rates, inflation expectations—measured by metrics like 10-year inflation breakeven rates—have jumped.
Potential inflationary pressures stem from proposed tariffs under the Trump administration and expansive fiscal policies. As investors anticipate higher inflation eroding their purchasing power, they demand higher nominal yields.
Fiscal policy is also playing a significant role. Increased government spending and growing deficits have led to a surge in Treasury issuance, known as “fiscal largesse.” With demand for Treasuries struggling to keep pace, this excess supply has pushed yields higher.
### **Quantitative Tightening and Policy Uncertainty**
The Federal Reserve’s ongoing quantitative tightening (QT)—allowing Treasuries to mature without reinvesting the proceeds—has reduced demand for long-term bonds. While the Fed recently tapered QT from $25 billion to $5 billion per month, which could alleviate some upward pressure on yields, the broader impact of QT remains a contributing factor in the rising 10-year Treasury yield.
Adding to market jitters is policy uncertainty, particularly regarding tariffs, fiscal measures, and the Trump administration’s broader economic agenda. This uncertainty has increased the risk premium investors demand for holding long-term Treasuries. Market participants now expect yields to reach 5% in the near term, reflecting concerns over fiscal deficits and inflation, further fueling the rise in bond yields.
While the prospect of economic expansion often brings optimism, for CRE investors, the reality is more complicated. Higher interest rates, borrowing costs, and valuation pressures continue to create a cautious investment climate amid an uncertain financial landscape.
