Against the odds! U.S. Treasuries achieve their strongest first half performance in five years

This month, the U.S. Treasury market achieved its best monthly return since February and recorded the strongest first half performance in five years. Currently, the yield on the U.S. 10-year Treasury bond hovers around 4.258%, close to a two-month low.

Despite experiencing a series of shocks during this period, including President Trump's erratic policies, tariff uncertainties, geopolitical turmoil, and Moody's downgrade, bond traders have still managed to make profits and extend a three-week rally.

Analysts believe that investors have largely ignored the impact of Trump's tax plan, instead focusing on the outlook for Federal Reserve policy, anticipating at least two rate cuts this year. The market's expectation for a rate cut in July has risen from virtually negligible at the beginning of the month to nearly 20%, while a rate cut in September is viewed as a certainty.

Traders are preparing for the possibility of the Federal Reserve acting sooner, especially in light of significantly weakening employment data and controlled inflation. The employment report set to be released on Thursday is seen as a potential catalyst. Economists expect that new jobs added in June will drop from the previous 139,000 to 113,000, with the unemployment rate potentially rising to 4.3%, reaching a new high since 2021.

Rate Cut Expectations Drive Bond Market Rebound; Employment Data May Be Key

George Catrambone, Head of Fixed Income at DWS Americas, stated, "The market leans towards a Federal Reserve rate cut, and there is a certain fear of missing out."

Since pausing rate cuts last December, the timing of when Federal Reserve officials will restart the easing cycle has garnered much attention. Catrambone has recently increased interest rate exposure, including 30-year bonds, partly because auction data shows stable foreign demand for U.S. Treasuries.

John Madziyire, a portfolio manager at Vanguard Group, pointed out, "For the Federal Reserve to cut rates more aggressively, the labor market needs to deteriorate. Everything in July hinges on the non-farm data, which is a key factor that could shake the market."

He believes holding 5-10 year U.S. Treasuries "is attractive because there are signs of an economic slowdown, and you are being compensated for taking on interest rate risk."

Dan Carter, a portfolio manager at Fort Washington Investment Advisors, stated that if the employment data is weak and inflation does not show the impact of tariffs, then a rate cut in July could become a reality. However, he also noted that this could be a delicate decision, and Federal Reserve Chairman Powell may prefer to delay until September.

Policy Divergence Increases Uncertainty

Despite a strong performance in June, yields remain relatively range-bound, considering that macroeconomic uncertainties may keep the Federal Reserve on the sidelines, with yields still well above the April lows. Bank of America, in its mid-year outlook, predicts that the U.S. two-year yield will reach 3.75% by the end of this year and 2026, while the 10-year yield will be at 4.5% Morgan Stanley's Global Macro Strategy Chief Matthew Hornbach stated last week that the bank expects the 10-year yield to drop to 4% by the end of this year and approach 3% by the end of 2026. He mentioned that while a rate cut is not anticipated this year, the Federal Reserve "will significantly cut rates next year."

Jamie Patton, Co-Head of Global Rates at TCW Group, compared the internal divisions within the Federal Reserve to "a dozen pilots sitting in the cockpit, disagreeing on the altitude to the destination airport," which increases the likelihood of policy missteps. She favors 2-year and 5-year Treasury bonds, believing these maturities will benefit the most in the event of an unexpected rate cut by the Federal Reserve.

Data shows that trading in interest rate options indicates a significant increase in bets on lower yields and a faster pace of rate cuts. Asset management firms favor 5-year U.S. Treasuries, believing this maturity will benefit from a larger-scale rebound in U.S. Treasuries extending into 2026.

Risk Warning and Disclaimer

The market carries risks, and investment should be approached with caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investment based on this is at one's own risk