Positioning Before The Next Leg Down for Treasury YieldsTreasury yields represent the ROI that investors can expect from buying U.S. government debt. Higher yield signals lower bond price and lower yields point to higher bond prices. So far this year, yields have eased chiefly due to Fed’s intention to slow the pace of its balance sheet runoff. Potential recession concerns are also weighing down on yields.
Yields remain unchanged since the start of March, presenting a compelling opportunity for investors to position ahead of a potential next leg lower.
Fed Holds Rates, Slows QT
As expected, the FOMC held rates steady at 4.25%–4.50% at its meeting last week. No rate cuts are expected until June. Fed’s March meeting was notable for the release of updated Fed projections and adjustments to the balance sheet runoff.
The meeting outcome was positive for Treasury prices and consequently negative for yields. It reaffirmed the rate outlook for the year and showed the Fed is close to ending its QT campaign.
Fed Nearing the End of QT?
The Fed announced it will reduce the monthly cap on Treasury runoff from USD 25 billion to USD 5 billion starting in April. This marks the first adjustment to the runoff since May 2024, signalling a gradual but continued slowdown in quantitative tightening (QT).
Chair Powell noted that the Fed is assessing how much longer QT can continue. Analysts interpret this move as a step toward its QT conclusion. End of QT supports Treasuries and putting downward pressure on yields.
Fed Outlook – Higher Inflation but Continued Rate Cuts
The Fed lowered its outlook for the US economy in 2025 and beyond but left its rate outlook unchanged in its latest economic projections.
Source: Federal Reserve
US GDP is expected to grow 1.7% in 2025 (v/s 2.1% as per December projections). Unemployment rate this year is expected to be 4.4% (v/s 4.3%) and inflation is expected at 2.7% (v/s 2.5%). Crucially, the Fed does not expect this slowdown to be transient as it also lowered its GDP outlook for 2026 & 2027.
The unchanged rate outlook was encouraging. It suggests the Fed expects to proceed with rate cuts as previously planned.
FedWatch Expectations Improve After Fed Confirmation
With the Fed staying committed to its rate forecast, market expectations have shifted upwards and now signal three rate cuts this year with another one expected in December.
Source: CME FedWatch
More rate cuts support lower Treasury yields, however, there may be downside risks to this outlook.
Fed’s Dot plot Shows Downside Risks for Rate Cuts
Source: Federal Reserve
According to the FOMC dot plot, while the forecast for rates has not shifted， individual member expectations have. The more dovish Fed members have shifted noticeably higher with them no longer expecting rates to fall more sharply in 2025.
Contrastingly, those expecting rates to fall more slowly have increased drastically.
Why this uncertainty in rate outlook? Two reasons. Potential economic slowdown and inflation relapse risk.
Recession Talks are Bubbling Again
Concerns are spiking over a slowing US economy. Atlanta Fed’s GDPNow forecast suggests that the US economy will shrink by 1.8% in Q1. Due to the sharp cut in federal jobs as well as slowing consumer spending, the downturn could be severe.
Source: Atlanta Fed
JP Morgan Chief Economist Bruce Kasman stated earlier this month that there is a 40% chance of a US recession this year. A CNBC survey of fund managers, strategists & analysts indicates rising recession expectations (from 23% in Jan to 36% in Mar) for this year.
Risks are emerging from Trump’s trade and fiscal policies. While the actual rollout of tariffs remains uncertain, with plans constantly in flux, a scenario which sees broad tariffs rolled out would lead to a slowdown in consumer spending with higher prices likely to pressure domestic demand.
President Trump has also acknowledged the possibility of a slowdown, stating earlier this month that there may be an uncomfortable transition period due to tariffs.
Inflation Concerns Pose Headwinds
Trump’s tariff policies are also raising inflation concerns. The Jan FOMC minutes highlighted Fed’s concerns that tariffs might have on the ongoing disinflation trend. Upside risks to inflation could slow the pace at which the Fed opts to reduce rates.
While a recession scenario is likely to push Treasury yields lower, if the Fed remains steadfast following a rebound in inflation, yields are likely to remain rangebound and volatile.
10Y Auction Demand Improving
Source: CME TreasuryWatch
The latest 10Y Treasury auction showed a higher bid-to-cover ratio of 2.59 compared to 2.48 in Feb and an average of 2.55 over the last ten auctions. While the overall sale was smaller, the improved bid-to-cover ratio nonetheless shows improving demand for 10Y treasuries supporting lower Treasury yields.
Hypothetical Trade Setup
Treasury yields are caught between the tug of rising inflation expectations and recession fears. Recession fears act to drive yields lower due to safe haven demand.
A reaffirmed rate outlook from the Fed also supports further downside on Treasury Yields. A short position in yields warrant a wider stop-loss to accommodate the potential risk to the upside on inflation relapse.
Technical summary of 10Y yield futures suggests a bearish outlook with an imminent MA crossover and MACD signalling a downturn.
Investors can express a view on further decline in Treasury yields using CME Yield futures. CME Yield Futures are quoted directly in yield with a 1 basis point (“bps”) change representing USD 10 in one lot of Yield Future contract.
This simplifies spread calculations with a 1 bps change in spread representing profit & loss of USD 10. The 10Y yield futures contract requires maintenance margin of USD 300 at the time of writing
The following hypothetical trade setup offers a reward to risk ratio of 1.46x:
• Entry: 4.25
• Target: 3.84
• Stop Loss: 4.53
• Profit at Target: USD 410 (41 basis points x USD 10)
• Loss at Stop: USD 280 (28 basis points x USD 10)
• Reward to Risk: 1.46x
MARKET DATA
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