Interest rates on government bonds may be higher now that long-term debt is out of favor

(Bloomberg) — Treasury yields rose Monday as traders continue to see a slower pace of Federal Reserve rate cuts next year and the potential worsening of the country’s fiscal environment under the administration of President-elect Donald Trump.

The rise in yields on longer-dated government bonds has outpaced that of shorter-dated government bonds, contributing to the steepening momentum of the yield curve in recent weeks. The difference between the ten-year interest rate and the interest rate maturing in two years is hovering around 25 basis points, up from almost zero at the start of the month. The two-year yield was one point 51 basis points higher than that of ten-year bonds earlier this year, in late June, in a so-called inverted yield curve pattern.

Monday’s moves built on a rise in yields last week after U.S. central banks’ latest quarterly projections – known as the dot plot – in which they halved estimates for the total amount of rate cuts next year. At the median level, the forecasts also favored the outlook for the Fed’s long-term interest rate, which the market considers a benchmark for the central bank’s neutral policy level.

“The long end has been flexing its muscles, with investors increasing the risk premium they see in debt,” said Andrew Brenner, head of international fixed income at NatAlliance Securities. “The fiscal situation is a factor behind the increase in the long-term risk premium and the prospects for more supply. Overall, we see a normalization of the yield curve.”

Interest rate swap contracts show traders betting on less than the two quarter-point cuts officials indicated in their dot plot. Until the end of 2025, only 0.33 percentage points of tariff reductions are priced into the contracts. No Fed officials will speak this week.

Treasuries remained under selling pressure on Monday despite a weaker-than-expected US consumer confidence report and solid demand at an auction of two-year Treasury notes. Confidence fell unexpectedly in December for the first time in three months due to concerns about politics and the prospects for tariffs and the economy.

What Bloomberg Strategists Say…

“In its latest scatterplot, the Fed implicitly outlined a true neutral policy rate of 100 basis points, a rate it has raised successively this year. While real neutral rates may not be that high, 10-year Treasury yields should reflect both skepticism that Fed policy is on autopilot and that real neutral rates could be higher than those estimated in the dot chart.”

— Ven Ram, Cross-Assets Strategist, Dubai

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Treasuries saw solid demand with sales of $69 billion in two-year bonds on Monday ahead of sales of $70 billion in five-year bonds on Tuesday and $44 billion in seven-year bonds on Thursday.

“Despite the dot plot’s suggestion that the Fed could slow the pace of easing through 2025, the 2-year versus 10-year yield curve has not flattened again,” said Chris Ahrens, strategist at Stifel Nicolaus & Co .

“This could be a signal that a transition is taking place where fiscal concerns and general policy uncertainty will lead investors to demand a higher term premium on long-term government bonds,” he said.

Tuesday will be a shortened trading session for both bonds and stocks in the US ahead of Wednesday’s Christmas holiday. Stock markets close at 1 p.m. New York time on Tuesday, while bond trading ends an hour later. Trading will resume on Thursday when the focus turns to economic releases and the weekly unemployment benefits report.

(This will update the rates.)

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