Why the U.S. 10-Year Yield Keeps Snapping Back to “Neutral”

Executive Summary

The 10-year U.S. Treasury yield has spent most of the past three years oscillating between 3.75% and 4.50%, with a rolling two-year average near 4.2%. That level increasingly represents market “neutral” — consistent with a fed funds rate just above 3%, inflation near 2.5%, and nominal growth expectations around 4%.

The Case for Neutral

Despite bouts of volatility, the 10-year U.S. Treasury yield has largely oscillated within a contained range over the past three years — briefly pushing above 4.50% at cycle peaks and falling below 3.50% during growth scares, but spending most of its time between 3.75% and 4.50%. On a rolling 24-month basis, the average sits near 4.2%, a level that increasingly reflects what markets interpret as “neutral” — consistent with a funds rate and inflation environment that is neither meaningfully stimulative nor restrictive.

The effective fed funds rate currently stands at 3.64%, modestly above most estimates of the long-run neutral rate (often cited between 3.00%–3.25% nominal). Yet the front end of the curve is already pricing normalization. The 2-year Treasury yield near 3.3% implies expectations for gradual easing over the next 12–18 months. Fed funds futures similarly suggest policy drifting toward a terminal range just above 3% into 2026. In short, the markets are transitioning toward steady-state conditions.

Inflation, Real Rates Support Equilibrium

Inflation data reinforces this equilibrium thesis. Headline CPI and PCE measures are running near 2.5% year-over-year, while 10-year breakeven inflation rates hover around 2.3%–2.4%, signaling anchored long-term expectations. Real 10-year yields sit near 1.8%–2.0%, historically consistent with trend growth around 1.75%–2.0%. If nominal growth expectations cluster near 4%, a 10-year yield in the low 4s is internally coherent.

Supply: More Narrative Than Disruption

Supply worries have so far been more of a narrative than a binding constraint. The Treasury has leaned heavily on bills and shorter coupons, helping fund large deficits without a dramatic steepening in the long end. At the same time, changes to the enhanced supplementary leverage ratio, effective April 1, 2026, will trim Tier 1 capital requirements for the largest banks by an estimated $13 billion at the holding-company level and roughly $219 billion across major bank subsidiaries. That shift should expand balance‑sheet capacity to hold Treasuries, partially offsetting the impact of any faster Fed balance‑sheet runoff.

Growth Risks, But Not Recession Pricing

The macro debate remains finely balanced. Growth is slowing from its late‑2025 pace, and markets are alert to downside risk, but fed funds futures still cluster around a 3% handle for the longer run rather than a plunge back toward zero. That tension between softer data and a still‑positive real policy rate helps explain the current curve: cautious, modestly upward‑sloping, but not screaming recession.

Absent a clear break in inflation, growth, or Fed guidance, the path of least resistance still points to a 10‑year yield that oscillates but ultimately gravitates back toward the 4.2% “neutral zone” that has defined this cycle’s rates regime.

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