How to view the recent sell-off of U.S. Treasuries? UBS: The main reason is the reduced probability of "economic recession," not grand narratives such as foreign capital sell-off or debt control issues
The UBS report shows that the 2-year U.S. Treasury bonds, reflecting cyclical narratives, have become the eye of the storm in recent market fluctuations, with yields soaring by 42 basis points over the past month. The decrease in the probability of "economic recession" is the main reason for the U.S. Treasury sell-off. Regarding the market's heated discussion on the U.S. Treasury crisis, UBS stated that there has indeed been a structural change in U.S. Treasuries, but it did not occur recently and is not driven by a debt crisis
Recently, the U.S. Treasury market has experienced significant volatility, with the 2-year Treasury yield soaring 42 basis points over the past month, while the 10-year and 30-year Treasury yields have both surpassed the psychological thresholds of 4.3% and 4.5%, respectively.
According to the Chase Wind Trading Desk, in response to the market's heated discussions about "foreign capital withdrawing from U.S. Treasuries" and "the U.S. debt crisis," the UBS Global Rates Strategy team pointed out in their latest report that the core driving force behind this round of Treasury sell-off is actually cyclical factors—the reduced probability of a U.S. "recession," rather than the long-term structural risks that the market is concerned about.
The probability of "recession" decreases, making the 2-year Treasury the eye of the storm
The UBS research report indicates that while structural explanations for the long-term rise in interest rates, such as foreign capital withdrawal and deficit concerns, are rampant, an analysis of the yield curve reveals that current market volatility is primarily concentrated on the 2-year Treasury yield, which reflects cyclical narratives.
Since April 30, the 2-year Treasury yield has surged 42 basis points, mainly due to a 50 basis point reduction in market expectations for the Federal Reserve's interest rate cuts in 2025.
At the same time, the yield spreads between the 2-year and 5-year, the 5-year and 10-year, as well as the 10-year and 30-year Treasury yields have only moderately flattened, with fluctuations in these spreads not exceeding 10 basis points over the past month. This indicates that the current volatility in U.S. Treasuries is primarily driven by changes in the probability of "recession," rather than a lasting structural shift.
Figure 1: Recent market volatility concentrated on the 2-year, showing that cyclical factors (decreased recession probability) dominate the sell-off
Structural pressure in the bond market is not significant
In response to the market's heated discussions about the U.S. Treasury crisis, UBS pointed out that while there have indeed been structural changes in U.S. Treasuries over the longer term, these changes did not occur recently.
The UBS report shows that the relationship between the 2-year and 5-year Treasury yield spreads and short-term interest rates has returned to levels seen before 2015, ending a very flat yield curve relative to interest rates over the past decade. However, this change in relationship primarily occurred in 2024, rather than recently. This indicates that the steepening of the curve is a natural adjustment of market mechanisms, rather than being driven by a debt crisis.
Figure 3: The shape of the yield curve has returned to levels seen before 2015; Figure 4: The "term premium" of U.S. Treasuries is rising
UBS believes that at current levels, interest rates are unlikely to rise significantly, and a 30-year bond yield close to 5% may provide attractive entry opportunities for long-term investors. Short-term risks mainly stem from potentially rising CPI data in the coming months.
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