US Treasury Yields Outlook for 2025: Is the Sell-Off Over?

Capital Economics weighs in on the future of US Treasury yields and the steepening yield curve.

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Capital Economics Analyzes 2025 US Treasury Yield Trends

The outlook for US Treasury yields is one of the key considerations for investors heading into 2025. While the US Treasury market has experienced fluctuations, particularly with the rise in yields throughout 2024, Capital Economics provides an insightful analysis, suggesting that the sell-off in Treasury yields might be reversing. This article explores the future trajectory of Treasury yields, including factors such as Federal Reserve policies, inflation concerns, and political uncertainty under President-elect Donald Trump.

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Factors Contributing to Rising Treasury Yields in 2024

As 2024 unfolded, US Treasury yields saw an increase, reflecting concerns about the Federal Reserve's interest rate policies. With the central bank reducing borrowing costs by a full percentage point in the earlier part of the year, investors were cautious about the potential for more cuts. However, the bond market’s reactions also revealed investor concerns about the future direction of US monetary policy. Specifically, the worry was centered on how the Federal Reserve would approach its next moves in response to changing economic conditions and political uncertainty.

Moreover, President-elect Donald Trump's proposed economic policies—particularly his plans for tariffs on both allies and adversaries—have raised concerns about inflation. Such policies could put upward pressure on prices, prompting the Federal Reserve to reconsider its rate-cutting stance. Investors have been watching these developments closely, with the possibility of higher inflation potentially delaying or even halting the Fed's plans for additional rate cuts.

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Capital Economics' 2025 Yield Forecast

While the Treasury sell-off dominated headlines throughout 2024, Capital Economics provides a relatively optimistic forecast for 2025. The analysts predict that Treasury yields will likely decrease over the course of the year. However, despite this overall downward trend, there may be a continuation of a steepening yield curve, especially at the longer end of the curve. A steepening yield curve typically occurs when long-term bond yields rise faster than short-term yields, signaling increased inflation or greater uncertainty in the economy.

Capital Economics forecasts the 10-year Treasury yield to end 2025 at 4.50%, just slightly below its current level. This suggests that while the overall trend may be downward, long-term yields could remain somewhat elevated compared to historical averages. Meanwhile, the short-end of the curve is expected to experience more pronounced declines, driven by expectations that the Fed will adopt a more cautious approach regarding future rate cuts.

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The Impact of Bear Steepening on Treasury Yields

One of the significant trends that investors should pay attention to in 2025 is the concept of "bear steepening" in the Treasury yield curve. In this scenario, long-term yields rise more sharply than short-term yields, creating a steeper curve. This phenomenon can indicate heightened expectations for inflation, increased volatility, or a growing risk of political and economic instability.

Bear steepening is often a sign that the market anticipates economic or political risk, which is a crucial factor for investors to consider when adjusting their strategies. For instance, as long-term yields rise faster than short-term ones, investors may demand more significant compensation for holding long-term bonds, given the potential for increased uncertainty or inflation in the future.

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Federal Reserve's Role in Shaping Treasury Yields

The Federal Reserve plays a pivotal role in determining the trajectory of Treasury yields, and its policies will be crucial in shaping bond market conditions throughout 2025. After slashing borrowing costs in 2024, the Fed has adopted a cautious stance towards additional rate cuts. While earlier predictions had suggested the Fed would continue cutting rates, softer-than-expected inflation data, such as the December consumer price index (CPI) report, has led investors to reevaluate the pace of future cuts.

In light of this, Capital Economics analysts highlight the fact that short-term Treasury yields are likely to remain relatively stable, while long-term yields may fluctuate more in response to inflation expectations. This dynamic presents an opportunity for investors to recalibrate their portfolios, focusing on bonds with varying maturities to balance risk and return.

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Trump's Policies and Their Effect on Inflation Expectations

Another critical factor influencing Treasury yields in 2025 is the potential for increased inflation due to President-elect Donald Trump's trade policies. His proposed tariffs on imports could lead to higher prices for goods and services, raising inflationary pressures. If inflation increases, the Federal Reserve may be less inclined to implement further rate cuts, which could stabilize or even increase long-term bond yields.

Moreover, the uncertainty surrounding Trump's broader economic agenda could continue to fuel investor concerns. As the new administration takes office, the potential for unexpected policy shifts will remain a risk factor for the bond market. This political volatility is a key element that analysts will continue to monitor as they make their predictions for Treasury yields in the coming year.

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Rising Treasury Term Premia and Their Impact on Yields

Another factor that analysts believe is contributing to the rise in long-term Treasury yields is the increase in Treasury term premia. This is the additional compensation that investors require to hold longer-term bonds, given the inherent risks of holding such securities for extended periods. With growing uncertainty surrounding inflation and political risks, investors may demand higher term premia, pushing long-term yields higher.

This trend has been particularly noticeable in the steepening of the yield curve, as long-end yields have risen more rapidly than short-term yields. Capital Economics suggests that this shift in market sentiment reflects concerns over potential future volatility, particularly as inflation expectations and political risks continue to evolve.

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What Investors Should Expect in 2025

Looking ahead to 2025, Capital Economics expects a mixed environment for Treasury yields. While yields are likely to fall overall, there is a strong possibility that the yield curve will steepen further. Investors should remain cautious, as rising inflation expectations and political risk could keep long-term yields elevated.

In particular, those holding long-term Treasury bonds may see more volatility as the bond market adjusts to the shifting economic landscape. However, with short-term yields expected to decline, there may be opportunities for those focused on shorter-duration bonds.

For investors, staying informed about economic data releases, such as CPI reports and Federal Reserve announcements, will be essential to understanding the direction of yields. Monitoring political developments, particularly in relation to Trump’s policies, will also be crucial for anticipating potential market reactions.

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Key Takeaways

• Treasury yields are expected to decline over 2025, but long-term yields may remain elevated due to inflation and political risks.
• A "bear steepening" of the yield curve, where long-term yields rise faster than short-term yields, is likely.
• Federal Reserve policies will play a key role in shaping Treasury yields, with the Fed expected to take a cautious approach toward future rate cuts.
• Political risks under President-elect Trump, including his proposed tariffs, could contribute to increased inflation expectations and affect bond yields.

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Summary

In 2025, Treasury yields are set to decline, but long-term yields may remain higher due to inflation concerns and political uncertainties. Bear steepening could continue as the market reacts to these factors, while the Federal Reserve’s cautious approach to rate cuts will keep short-term yields stable. Investors must monitor inflation and political developments closely.

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Q&A Based on Search Engine Queries:

Q: Will Treasury yields continue to rise in 2025?
A: While Treasury yields are expected to fall, long-term yields could remain elevated due to inflation concerns and political risks.

Q: What is a "bear steepening" yield curve?
A: "Bear steepening" refers to a situation where long-term yields rise faster than short-term yields, often indicating inflation concerns and economic uncertainty.

Q: How do Federal Reserve policies affect Treasury yields?
A: The Federal Reserve’s interest rate decisions influence Treasury yields, with rate cuts typically leading to lower yields, and cautious rate policies keeping yields relatively stable.

Q: What impact could Trump’s tariffs have on Treasury yields?
A: President Trump’s proposed tariffs could lead to higher inflation, which may prompt the Federal Reserve to delay or limit future rate cuts, keeping long-term Treasury yields higher.