Did the Fed make a mistake with its October rate pause? The Treasury could help save the day.

By Joy Wiltermuth and Greg Robb

As focus shifts to the Treasury's future funding plans, there's some expectation that longer-term supply could be reduced in an attempt to boost demand and lower yields

As some question Fed Chair Kevin Warsh's commitment to fighting inflation, Treasury chief Scott Bessent, left, could reduce supply to help keep longer-term yields capped.

Expectations are running high for the Treasury Department to provide some cover next week for the Federal Reserve over its decision to avoid hiking interest rates in October despite a hot inflation backdrop.

Economic data on Thursday underscored that the U.S. economy keeps powering along - despite higher borrowing costs - in no small part because of the artificial-intelligence spending boom.

Gross domestic product, the official government scorecard, expanded at an inflation-adjusted 3.4% annual pace in the third quarter, the government said, above expectations of 3.1% growth. Nominal GDP, which doesn't remove inflation, increased at a torrid 5.6% annual rate.

Fed Chairman Kevin Warsh on Wednesday said anyone second-guessing the central bank's determination to get inflation back to 2% would be making a mistake. Yet the Fed also decided to hold off on hiking rates, with Warsh suggesting an "information-rich" backdrop as the reason.

"But if that's the case, what are you waiting for?" said Jim Baird, chief investment officer at Plante Moran Financial Advisors, in a call Thursday following the latest batch of economic data. "It is tough to square right now."

Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, said that "October was a bit of a write-off." It was always going to be difficult for Warsh to convey a "hawkish pause," he said, or an aggressive stance on fighting inflation, "unless there was a good explanation for why the Fed didn't go."

The pause also makes a December rate hike look more likely.

Yet in the wake of the October pause, the focus will quickly turn to the Treasury Department's looming release of its funding plans for the next quarter, on Nov. 4. This will be crucial, between long-dated Treasury yields hitting 24-year highs earlier this month, ongoing U.S. funding needs and the $2 trillion budget deficit.

Yields on the inflation-sensitive 30-year Treasury bond BX:TMUBMUSD30Y spiked higher during Warsh's news briefing Wednesday, but retreated Thursday as investors looked for cover in U.S. government debt as tech stocks fell sharply.

Goldberg at TD said the yield jump on Wednesday can be linked to worries about the Fed's credibility on fighting inflation, but also concerns about heavy U.S. Treasury supply amid the deluge of AI debt the market has been digesting this year.

With that backdrop, Goldberg's team expects the Treasury to hint next Wednesday at smaller Treasury-auction sizes for 10-year and 30-year supply next year, eventually removing about 11% of gross long-dated issuance from the market on a quarterly basis.

Under this scenario, the Treasury would follow that up with increased supply of 2-year BX:TMUBMUSD02Y to 10-year BX:TMUBMUSD10Y supply, with the aim of taking some of the heat out of rising longer-dated yields. Prices of notes and bonds move in the opposite direction of yields.

Practically, the idea is to make mortgage loans more affordable, keep a lid on borrowing costs for businesses and ease some of the burden on taxpayers funding the U.S. deficit.

The 10-year Treasury yield has surged 42.4 basis points since the day before Warsh was sworn in as Fed chairman on May 22. That's the biggest such rise to start a term since Ben Bernanke was sworn in on Feb. 1, 2006, according to Dow Jones Market Data. One basis point is 0.01 percentage point.

"Part of what we've seen is this big surge in long-term yields that started in the aftermath of the transition" to Warsh from former Fed Chair Jerome Powell, said Baird at Plante Moran.

It's been taking some time for investors to adjust to Warsh's tight-lipped style, he said. But other pressures also have played roles in recent rate volatility, including concerns about inflation, the large U.S. debt load and the barrage of debt issuance tied to the AI build-out this year.

"Nothing takes place in a vacuum," Baird said. "But 5% yields alone aren't going to tank the economy."

Instead, higher yields have been a game-changer for some of Baird's clients and their portfolios.

"There are yields on high-quality paper that we haven't seen for 25 years," he said. "For your typical investor, who thought they might need to invest [mainly] in stocks, finally, you are seeing bond portfolios doing much more of the heavy lifting." Those higher yields allow many investors to just take less risk, he added.

-Joy Wiltermuth -Greg Robb

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10-29-26 1400ET