Due to the decreased probability of an economic recession in the United States and the potential for Trump's trade policies to raise inflation, market expectations for aggressive interest rate cuts by the Federal Reserve have cooled, leading to a wave of sell-offs in long-term U.S. Treasury bonds, exacerbating the steepening of the yield curve. Against the backdrop of high global debt, the "disfavor" of long-term U.S. Treasury bonds may continue.
When the market suddenly realized that the Federal Reserve might not cut interest rates as aggressively as expected, long-term U.S. Treasuries were experiencing a "flight".
The Federal Reserve's policy-making committee will conclude its two-day meeting on Wednesday, with the market generally expecting the benchmark overnight rate to remain in the Range of 4.25%-4.50%. As the probability of a U.S. economic recession decreases, market expectations for aggressive easing are cooling, while Trump's trade policies may still push inflation up in the second half of the year.
"There is a reason that the 30-year Treasury yield is approaching 5%, and that is because Selling duration faces tremendous pressure,” said Neil Aggarwal, head of securitized products and portfolio manager at Indianapolis Reams Asset Management.
"There are concerns about volatility recently, and from a short-term perspective, if you expect volatility to persist, it's very difficult to have a long duration."
However, the weak consumer and producer price data in May injected new vitality into the expectations for rate cuts. Federal Funds Futures indicate that the market believes the Federal Reserve's probability of cutting rates twice starting in September has increased. Before the latest inflation data was released, the market expected a rate cut in September and then another in December.
Fiscal concerns are exacerbating the steepening of the yield curve.
"I don't necessarily want to have a long duration,” said Victoria Fernandez, chief market strategist and fixed income portfolio manager at Houston's Crossmark Global Investments. Although traders bet that the Fed's next rate cut will be in July or September, Fernandez believes that the cut may not happen until "the end of the year or even next year."
The latest JPMorgan Treasury customer survey and the active core Bonds SSE Fund Index show that long-duration U.S. Treasury positions have decreased over the past two months. The lackluster response to the 30-year bond auctions in April and May has further amplified the market's reluctance to hold long-term debt.
Analysts say this trend is partly attributed to the weakening expectations of a recession in the U.S. Goldman Sachs downgraded the probability of a recession in the U.S. over the next 12 months from 35% to 30% last week, citing easing uncertainty around Trump's tariff policies.
More concerning is Trump's "Big Beautiful Bill." The bill has passed the House and is currently being debated in the Senate. According to estimates from the Congressional Budget Office, the bill could increase the deficit by $2.4 trillion over the next decade, at a time when U.S. debt has already surged as a share of GDP.
"In this cycle, there are reasonable arguments for a steepening of the government yield curve," said Danny Zaid, Portfolio Manager at New York's TwentyFour Asset Management.
"As an investor, you should demand more compensation from a government with a debt to GDP ratio of 120% compared to one at 70%."
The steepening of the yield curve may continue.
The "steepening" trade of the yield curve has been quite popular since the Federal Reserve began its easing cycle at the end of 2024. This strategy involves bullish bets on short-term Treasuries while reducing exposure to long-term ones, thereby pushing up long-term Treasury yields, according to Brendan Murphy, Head of North American Fixed Income at Boston Insight Investment.
"We believe the yield curve can steepen further. We are overweight in duration but more concentrated at the front end rather than the back end, being more cautious on the 30-year segment, mainly due to the uncertainty around fiscal expansion and the potential risk of tariffs pushing up inflation."
Investors will also pay attention on Wednesday to the latest quarterly economic forecasts released by Federal Reserve policymakers, including the interest rate predictions reflected in the "dot plot." The "dot plot" from the March meeting shows that by the end of 2025, the policy interest rate will be 3.75%-4.00%, indicating two rate cuts of 25 basis points each.
Bond investors expect that the Federal Reserve will not change its policy interest rate forecasts. In this context, the "disfavor" of long-term government bonds may just be a beginning.
Editor/Rocky