The U.Sbond market is currently experiencing a paradoxical situation: despite the Federal Reserve's substantial rate cuts, Treasury yields are on the riseSince central banks began significantly lowering benchmark interest rates in September, the yield on 10-year U.STreasuries has surged by over 75 basis points, marking the most significant increase for this yield during the first three months of a rate-cutting cycle since 1989.

Bond traders seldom see such considerable losses amidst a Fed easing cycleNow, concerns are mounting about the potential for similar scenarios to arise in 2025. Just last week, coinciding with the Fed's third consecutive rate cut, the yield on the 10-year U.STreasury soared to a seven-month high after Fed Chairman Jerome Powell and his colleagues signaled a readiness to slow the pace of monetary easing significantly next year.

Sean Simko, the global head of fixed income portfolio management at SEI Investments Co., stated, "The government bonds are being repriced, aligning with the perspective that yields will be higher for longer and the Fed will take a more hawkish stance." He anticipates that this trend will persist as long-term yields continue to rise.

The rise in yields underscores the distinctiveness of the current economic and monetary cycles

Even as borrowing costs increase, a robust U.Seconomy keeps inflation above the Fed’s target, compelling traders to reconsider their bets on significant rate cuts and to relinquish hopes for an all-encompassing rally in bondsAfter a year marked by volatility, traders are now staring down another disappointing year, with U.STreasury investments barely breaking even.

On a positive note, a popular strategy that proved effective during previous easing cycles is gaining momentum againThis strategy, known as "steepening the curve," bets on short-term U.STreasuries outperforming their long-term counterparts—recently, this has indeed been the case.

The future of the U.Sbond market looks particularly challengingInvestors face not only the possibility of a static Federal Reserve for an extended period but also potential turmoil spawned by new government policiesMany experts believe that the administration’s ambitious agenda, ranging from trade to immigration reforms, could ignite inflation and, consequently, limit the extent of future Fed rate cuts.

Jack McIntyre, a portfolio manager at Brandywine Global Investment Management, remarked, "The Federal Reserve has entered a new phase of monetary policy—one characterized by stagnation

• The Challenges Behind Hikvision's Peak Amid Layoff Turmoil
• A-share Market Shifts into Rapid Rotation Phase
• Semiconductor Equipment Enters a Period of High Prosperity
• Robust U.S. Economic Data
• Institutional Demand Fuels Dividend ETF Growth

The longer this phase lasts, the more likely the market will react similarly to rate hikes and cutsThe uncertainty surrounding policies will make financial markets more volatile in 2025."

Alyce Andres, a strategist at Bloomberg, noted, "With the Fed's final meeting of the year behind us, the outcomes may lend support to a steeper curve as we approach year-endHowever, due to the uncertainties surrounding the government's new policies, this dynamic could stall."

Last week, Fed policymakers indicated a new sense of caution regarding the pace at which they are lowering borrowing costs, surprising bond traders amidst ongoing inflation concernsFed officials anticipate only two additional rate cuts of 25 basis points each in 2025, having already lowered rates by a whole percentage point from their highest level in two decadesNotably, 15 out of 19 Fed officials identified upside risks to inflation, a marked increase from just three in September.

Traders quickly recalibrated their rate expectations

Swap rates suggest that traders have yet to fully absorb the Fed’s anticipated further rate cut by June of the upcoming yearThey are estimating around 37 basis points of total cuts next year, below the 50 basis points median forecast reflected in the Fed’s dot plotHowever, the options market is leaning towards a more gentle policy trajectory.

Bloomberg's U.STreasury benchmark index fell for the second consecutive week, almost erasing gains made this year, particularly in long-term bondsSince the Fed started its rate cuts in September, U.Sgovernment bonds have declined by 3.6%. In contrast, historically, bonds offered positive returns in the first three months of the past six easing cycles.

The recent downturn in long-term bond prices has yet to attract many bargain huntersWhile strategists from JPMorgan, led by Jay Barry, have recommended clients buy two-year Treasuries, they expressed that they "see no need" to purchase longer-term bonds due to a scarcity of essential economic data in the coming weeks, limited trading activity toward year-end, and new supply on the horizon

The U.STreasury plans to auction $183 billion in bonds in the coming days.

The current environment has created ideal conditions for the steepening strategyThe yield on the 10-year Treasury rose well above the two-year yield by 25 basis points last week, creating the widest spread since 2022. Data released last Friday indicated that the inflation gauge favored by the Fed experienced its lowest monthly increase since May, resulting in a contraction of this spreadNonetheless, this trading approach remains profitable.

The logic behind this strategy is straightforwardInvestors are beginning to recognize the value of short-term bonds, as the two-year Treasury yield, currently at 4.3%, is nearly comparable to that of three-month Treasury billsHowever, should the Fed cut rates more than anticipated, the two-year Treasury carries an additional advantage: its price could potentially rise

Given the overvaluation of U.Sequities, these bonds also provide value from a cross-asset perspective.

Michael de Pass, head of global rates trading at Citadel Securities, conveyed, "Markets perceive bonds as cheap relative to stocks and view them as insurance against an economic slowdownThe question is, how much do you need to pay for that insurance? If you look at the front end of the curve now, you won't have to pay much."

In stark contrast, long-term bonds are struggling to attract buyers amidst persistently high inflation and a robust economySome investors remain cautious regarding the U.Spolicy platform, fearing it could not only stimulate economic growth and inflation but also exacerbate the already substantial budget deficit.

Michael Hunstad, the deputy chief investment officer at Northern Trust Asset Management, which manages $1.3 trillion in assets, remarked, "Once you start considering spending factors, it will definitely push those long-term yields higher." Hunstad expressed optimism about inflation-protected securities, viewing them as "a relatively inexpensive form of insurance" against rising consumer prices.