Imagine a landscape where borrowing costs finally feel more 'normal,' promising potentially stabilizing signals for financial markets—yet, beneath this calm surface, questions linger about where we’re truly headed. But here's where it gets controversial... Our latest analysis of interest rate trends reveals that we're witnessing a rare moment where the short-term funding rates dip below the long-term rates, reshaping the traditional yield curve expectations.
We have recently released our comprehensive Outlook for 2026, which thoroughly examines the evolving rate environment—check it out here (https://think.ing.com/bundles/rates-outlook-2026-situation-normal-all-fuddled-up/). The Federal Reserve's recent move was a cut that carried hawkish overtones, with Chairman Powell expressing notable concern about the strength of the labor market rather than focusing solely on inflationary pressures. Interestingly, this decision hints at the possibility of a renewed form of quantitative easing, especially given the Fed’s newfound flexibility to extend bond purchases out to three-year Treasuries if economic conditions demand it.
And this is the part most people miss: the fact that the federal funds rate is now below the 10-year SOFR rate—an indicator of more normalized market conditions. The recent meetings of the Federal Open Market Committee (FOMC) seem to point toward a convergence of key rates toward a kind of 'landing zone,' even if only temporarily. The Fed has now put its balance sheet on hold—effectively stopping further asset reduction—and has set a floor for bank reserves. Simultaneously, the funds rate is settling into a range that better reflects historic norms.
Let's explore both elements—first, the significance of the current level of the funds rate and other floating rates.
The most striking development is that the 3-month SOFR rate has finally fallen below the 10-year SOFR rate, marking a historic shift. What does this mean? Essentially, it signals that borrowing on floating-rate instruments has become more cost-effective than fixed-rate borrowing. This is a crucial change for lenders and borrowers alike. Over recent weeks, the 10-year SOFR has faced upward pressure, making fixed-rate borrowing relatively more attractive—until now. Conversely, the 3-month SOFR has been tempered by expectations of rate cuts, making short-term borrowing cheaper. This is the first time since late 2022—and very briefly in early 2025—that the long-term SOFR has been surpassed by shorter-term floating rates, and this trend is likely to accelerate if the Fed implements a further 25 basis point cut soon.
For market participants previously hesitant to switch to floating loans due to concerns about negative carry (the cost of holding a position with lower yields than the fixed alternative), this change could make floating-rate debt a more appealing option—at least as long as the 10-year SOFR remains elevated.
Next, let's consider liquidity dynamics. Over the past few months, the repo market—used for short-term borrowing—has been tightening significantly. Problems became even more pronounced when the effective funds rate, which is the actual rate at which reserves are traded overnight, began to detach from the target rate and inch closer to the interest paid on excess reserves (which is now just 1 basis point below the effective rate). The Fed responded at the previous FOMC meeting by adjusting its strategy—essentially reconciling its balance sheet measures—to absorb the excess liquidity by buying T-bills as some MBS roll-offs occur. But, as we've highlighted before, the Fed will ultimately need to expand its holdings in line with economic growth, which typically means a 3-5% increase in nominal GDP should be matched by reserve expansion.
To address this, the Fed has introduced a flexible plan to purchase T-bills exceeding the amount lost from MBS roll-offs—an approach reminiscent of Quantitative Easing (QE). They will start with approximately $40 billion in T-bill purchases and may phase out this activity later, depending on seasonal liquidity needs. This strategy is especially beneficial for the front end of the yield curve, helping to maintain ample liquidity.
Looking ahead to Thursday’s market calendar, there isn’t much significant data from Europe, but the U.S. will release trade balance figures for September as well as weekly jobless claims, with analysts expecting claims to rise from 191,000 to about 220,000. Additionally, Andrew Bailey of the Bank of England will be discussing financial stability, likely providing insights into UK monetary policy.
On the issuance front, Italy is set to auction €5 billion across 3-, 4-, and 5-year BTPs, while the United States will conduct a sizable $22 billion auction of 30-year bonds. These auctions can influence yields and investor sentiment in the coming weeks.
So, what do you think? Are these shifts signaling a more balanced rate environment or a precursor to more turbulence? Do you agree that the move below the 10-year SOFR could reshape borrowing strategies and market dynamics? Or is this just a temporary blip? We invite your thoughts and debates below—let’s challenge each other's perspectives!
Disclaimer: This material is for informational purposes only. It does not constitute financial advice, and readers should evaluate their own circumstances before making investment decisions.
