Unlike past easing cycles, today’s environment is defined by large fiscal deficits, sticky inflation and surprisingly resilient growth.
The yield curve remains one of the most closely watched barometers of economic and policy expectations. We track its shape through the spread between the 3-month Treasury bill yield and the U.S. 10-year Treasury yield. Today, that spread sits just above flat, but both market pricing and our outlook suggest the curve is likely to steepen further over the coming quarters as the Federal Reserve (Fed) resumes rate cuts, a common occurrence in cutting cycles. For investors, the key question is which rates will move lower — and which may not.
As the Fed re-embarks on an easing cycle, the front end of the curve — 3-month to 2-year maturities — will decline most sharply, with the bulk of cuts expected over the next twelve months. However, the long end of the curve faces very different pressures. Unlike past easing cycles, today’s environment is defined by large fiscal deficits, sticky inflation and surprisingly resilient growth. These dynamics suggest the U.S. 10-year yield is likely to stay anchored above 4%, with risks skewed toward higher yields.
We have seen this movie before. During the Fed’s initial round of cuts in late 2024, the curve twisted steeper as markets anticipated lower policy rates, but long yields rose amid firm labor markets, strong private demand and higher inflation. Current expectations look strikingly similar: forward curves imply steepening from just 0.14% today to nearly 1% by 2027, driven by lower short-term rates and higher long-term rates.
The drivers of a steeper curve matter. In this environment, upward pressure on long rates from chronic deficits, tariff-related inflation and a near-term fiscal boost create a challenging backdrop for long-duration strategies. This means the old playbook of buying long bonds into Fed cuts may not work as well. Instead, total returns in long-dated Treasuries are likely to come primarily from income and coupon rather than capital appreciation.
As the Fed cuts, short rates will fall while long rates could remain sticky. Investors should recognize that this steepening may not be a uniform decline across the curve, but rather a twist. For investors, the 2–5-year part of the Treasury curve remains the sweet spot: yields are still attractive without overextending duration. Moreover, actively managed strategies that focus on duration management and income, and invest across securitized, corporate credit, emerging markets and extended sectors look best positioned to navigate a steeper curve.