The US Treasury market witnessed a significant shift on Tuesday, with the yield curve steepening to its highest level in nearly nine months. This key development signals that traders are increasingly betting on further interest rate cuts by the Federal Reserve, potentially extending into 2026.
Key Milestone Reached as Curve Steepens
The gap between the 10-year and two-year Treasury yields briefly exceeded 72 basis points for the first time since April. This move, known as yield-curve steepening, is fundamentally driven by market expectations for more policy easing from the Federal Reserve. The two-year yield settled around 3.47% on Tuesday, while the 10-year yield was near 4.18%.
Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities, believes the differential has the potential to widen to a full percentage point this year, which would be the widest gap since 2021. He projects the respective yields could fall to about 3% and 4%. "The curve will grind steeper because the economy is in good shape and a weak labor market keeps the Fed in play," Faranello stated.
Corporate Bond Surge and Global Factors at Play
A major factor exacerbating the steepening trend is a surge in corporate bond sales at the start of the year. After a halt in mid-December, issuance has roared back. Approximately 22 issuers were looking to sell investment-grade bonds on Tuesday, following Monday's 20 offerings that raised over $37 billion in the market's busiest day in months. This influx of supply puts upward pressure on long-term yields.
Global dynamics also contributed. Tom di Galoma of Mischler Financial Group noted that soft demand at an auction of 10-year Japanese government bonds lifted yields in that market. Conversely, most European government bond markets saw yields fall, spurred by benign German regional inflation data.
Diverging Views Within the Federal Reserve
The market's moves come amid a complex backdrop for US monetary policy. While Fed policymakers are broadly expected to lower the target range for overnight lending rates further this year—following three quarter-point cuts in September, October, and December—opinions on the pace differ.
Fed Governor Stephen Miran, who took office in September and has repeatedly dissented in favor of larger cuts, argued on Fox Business Network that more than a full percentage point of cuts is needed this year. However, market-implied expectations for a mid-year and a year-end quarter-point cut were little changed on Tuesday.
Several other Fed officials have voiced caution, citing inflation that continues to exceed the central bank's 2% target and accommodative financial conditions. They have argued for pausing rate cuts beginning this month. Consequently, traders assign a low probability to a cut at the Fed's next scheduled decision on January 28.
Despite the recent rise, yields remain below last year's peak levels. The short-maturity tenors, most sensitive to Fed rate changes, have declined the most. The differential between two- and 10-year yields was less than 50 basis points as recently as November, highlighting the rapid pace of the recent steepening. All eyes are now on key employment data releases over the next few days, which will provide the next major test for these market dynamics.
