Why were U.S. Treasury yields rising?

U.S. Treasury yields have seen large swings over the past few weeks; the U.S. 10-year touched a low of 3.87% on April 4th, increased to 4.59% on April 11th, and has since settled at 4.38% at the time of writing. Short-term rates have also swung within a 60 basis points (bps) range during the same period. The rise in yields in the face of rising recession risk and the uncertainty from the tariff announcements in Washington, goes against the traditional view of falling yields or rising prices for safe-haven assets like U.S. Treasuries. We believe multiple factors are contributing to the rise in yields, including policy uncertainty, deleveraging, and slowing demand. Key factors influencing the move in rates include: 

• Inflationary trade tensions and Federal Reserve (Fed) policy: Tariff announcements and retaliation are raising concerns about higher near-term inflation. Recent Fed commentary highlights these inflationary risks, suggesting the committee may not cut rates as aggressively as the market has priced in.
• Foreign demand for US treasuries: Treasury bond auctions during the week were mixed with the 3-year auction showing weak demand, while the 10-year and 30-year auction were well received. On balance, there is demand for Treasuries at these yield levels, but it is concerning that long-end yields continued to rise while the U.S. dollar fell, signaling there may have been some softening in foreign demand.
• Hedge funds deleveraging: The price difference between Treasury cash bonds and their future contracts underpins the nature of the “basis trade”. In this arbitrage trade, basis traders use the price difference of the two through selling Treasury cash bond futures and buying cash bonds. They are betting that the price of cash bonds will rise relative to the price of its futures and boost their profits by borrowing money (adding leverage) to increase the position size. This trade was losing money as yields rose and cash bonds fell in value and given leverage, traders faced margin calls or financing pressures. As losses increased, traders had to liquidate (sell) their cash bonds to cover losses or meet funding obligations, creating a feedback loop where rising yields led to more losses, prompting further selling. 
• Rising term premium: Investors are seeking greater compensation for holding longer dated Treasuries given the ongoing concerns about the U.S. government’s fiscal outlook. The reconciliation bill progressing through Congress, for example, could add trillions to the existing U.S. debt levels. In the long run, expansive fiscal policy may add to government bond volatility and keep the yield curve steep. 

As outlined, such a sharp movement in rates is typically driven by several factors coming together simultaneously. For investors, the Fed can only conduct monetary policy effectively, if markets are functioning efficiently. Therefore, continued notable changes in rates will likely prompt Fed intervention through balance sheet adjustments or establishing a liquidity facility to ensure market functioning, as similar actions were taken in previous periods of market stress. 

What is the outlook for monetary policy?

For the Fed, it is in a wait-and-see mode given the uncertainties from the Trump administration on a broad range of policy implementations, especially on tariffs. It is facing a growing dilemma of higher inflation from imported goods, as well as the downside risk from more cautious business and consumer sentiment. This was reflected in its inflation and growth forecast in the March Federal Open Market Committee’s (FOMC’s) Summary of Economic Projections, and before the revolving door of tariff announcements. That said, recent Fed speaks still emphasize the importance of ensuring inflation aligns with its target. Meanwhile, the FOMC may want to demonstrate its independence against pressure from the Trump administration to cut rates. This implies any rate cuts would need to be supported by weaker data, especially from the job market.

The overnight index swap (OIS) market is currently pricing in an 80% chance of a 25bps rate cut in June, and 3-4 rate cuts (25bps each) by the end of the year. Given the Fed’s approach of well telegraphed rate moves, three rate cuts for the rest of the year is a reasonable base case. This would bring its policy rate to 3.5-3.75% by the end of 2025, which is still above neutral. While June is arguably the earliest the Fed might act, this would need to be justified by softening March and April personal consumption expenditure (PCE) deflator data and job numbers.

Ultimately, it depends on how the growth outlook evolves: maintaining status quo or a re-escalation of trade tensions. The underlying health and momentum of the U.S. economy is still intact, as hard data is signaling a slower or flat growth in the coming quarters, which should allow the Fed to ease gradually. However, tariffs, a policy-induced shock, could push a resilient economy into a recession in 2H25, albeit a shallow one. This could accelerate the pace of Fed rate cuts to bring rates towards neutral, once labor market data shows signs of weakness. 

Investment implications

Recent yield volatility has raised investor concerns regarding the safe haven status of U.S. Treasuries during equity market pullbacks. However, this unusual behavior is caused by a flurry of factors happening simultaneously. The Fed is also able to intervene if such dramatic moves persist.

Thus, given the current environment, bonds still have the ability to hedge against downside growth risks, and we believe yields at current levels may offer a buying opportunity for long-term investors.

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