The Federal Reserve's hawkish actions trigger a huge change in U.S. Treasuries! The yield curve reaches its steepest since 2022

According to Zhitong Finance APP, long-term U.S. Treasury bonds weakened on Thursday, pushing the yield curve significantly steeper, returning to levels seen about 30 months ago. This change was mainly influenced by the Federal Reserve's hawkish interest rate policy, which is expected to reduce the number of rate cuts next year. Specifically, the yield on the two-year Treasury bond fell by 4 basis points to 4.31%, while the yield on the ten-year Treasury bond rose by about 8 basis points to an intraday high of 4.59%, close to the highest level since the end of May, with the yield difference between the two reaching 0.27 percentage points, the first time since June 2022.

The Federal Reserve has lowered its policy rate by one percentage point in recent months, but investors are reluctant to hold long-term Treasury bonds due to high inflation and a strong economy, leading to a steepening of the yield curve. Ian Lyngen, head of U.S. interest rate strategy at BMO Capital Markets, pointed out that the weakness at the long end of the yield curve is related to the Federal Reserve's hawkish stance, ongoing supply concerns, and investors' cautious attitude before decisive price actions. He expects the trend of a steepening curve to continue until the end of 2024.

Figure 1

In addition, bond investors are also paying attention to the potential tax policies that incoming President Donald Trump may introduce, which could stimulate economic growth and inflation, exacerbating the budget deficit.

The Federal Reserve also indicated that due to a lack of progress towards the 2% inflation target, it is expected to cut rates only twice throughout 2025, further pushing the benchmark ten-year Treasury yield above 4.5%.

In the inflation market, a cautious attitude towards U.S. Treasury bonds is also evident. For example, a $22 billion auction of five-year Treasury Inflation-Protected Securities attracted weak demand from non-dealers, with the clearing price rising significantly.

At the same time, some traders are beginning to focus on the prospect of the Federal Reserve potentially starting to raise rates sometime next year, with the options market trading two large transactions supporting the Fed's shift to a hawkish stance before the end of 2025.

The decline in the ten-year U.S. Treasury bond is built on a foundation of consecutive declines, leading its yield to rebound from a low of 3.60% in mid-September. During this period, the yield curve between the two-year and ten-year yields turned positive after a prolonged inversion.

Figure 2

Asset management companies generally prefer to hold short-term bonds to cope with the deficit outlook, the Federal Reserve's rate cuts, and the uncertainties of Trump administration policies, which also contributes to the steepening of the yield curve BlackRock portfolio manager Russell Burbank stated that considering the uncertainty of policies next year, they prefer to hold short to medium-term bonds and maintain a cautious attitude towards long-term bonds and the yield curve.

In addition, Thursday's economic data also showed that third-quarter economic growth was slightly above expectations and the number of initial unemployment claims was lower than expected, further intensifying investors' preference for short-term bonds.

It is worth mentioning that despite the Federal Reserve's efforts to bring the core inflation rate down to the target level of 2%, the indicator rose to 2.3% in October. The inflation data for November, expected to be released on Friday, is anticipated to further climb to 2.5%, while the core price index is expected to reach a high of 2.9%