Will the steepening trading trend continue? Double Line Capital: The Federal Reserve's interest rate cuts will further widen the 2/10Y U.S. Treasury yield spread

According to the Zhitong Finance APP, Bill Campbell, the global sovereign debt portfolio manager at DoubleLine Capital, stated that if the Federal Reserve takes aggressive rate cuts, the U.S. yield curve will steepen further. Campbell expects that loose monetary policy will encourage risk-taking behavior in the credit market, but will have little effect on pushing up long-term yields, which may prolong the period during which risk assets trade at high valuation levels.

Currently, the yield on U.S. 2-year Treasury bonds is close to its lowest level since 2022, while the yield on U.S. 10-year Treasury bonds is at its lowest point in five months, due to market expectations of rate declines. Campbell said, "This could allow the trading prices of risk assets and credit assets to remain at extremely high levels. The most obvious manifestation of these issues may be a weaker dollar and a steepening yield curve."

This year, long-term U.S. Treasuries have performed poorly, leading to the spread on the yield curve reaching its highest level in years. Currently, the yield difference between 2-year and 10-year U.S. Treasuries is about 58 basis points, while at the end of February, this difference was only 20 basis points.

Campbell believes that this difference could increase by another 75 to 100 basis points throughout the market cycle. This is because investors expect the Federal Reserve to be more tolerant of inflation in the face of increasing debt supply and to be more inclined to ease policy. This would match the spread of nearly 158 basis points in March 2021.

The U.S. non-farm payroll data released last Friday was disappointing, which further convinced people that the Federal Reserve would have to act quickly to support the labor market, leading traders to expect nearly three rate cuts this year. Policymakers will make their next interest rate decision on September 17.

Not only is the labor market putting pressure on the Federal Reserve to act faster, but the U.S. government will also face a heavy burden of maturing debt in the coming years, which was borrowed at lower interest rates.

In a report on Monday, Campbell wrote that more than $3.4 trillion in U.S. Treasuries will mature next year, with an average interest rate of 2.78%, far below the current 2-year yield of 3.5% or the 10-year yield of 4.07%. If the U.S. Treasury refinances maturing debt at the current 2-year rate, taxpayers will bear an additional interest burden of over $25 billion annually.

This is just one of the urgent issues. The total amount of U.S. Treasuries currently in circulation is about $29 trillion, most of which were issued at lower interest rates. As these debts mature, the U.S. Treasury has indicated that it will issue more short-term bonds to avoid locking in interest rates at 4% for the coming decades. This will only make the U.S. borrowing costs more closely tied to the Federal Reserve's policies The continuous rise in fiscal deficits and long-term funding costs is putting pressure on countries around the world. France is a typical example, as the current Prime Minister François Bayrou will face a vote of confidence this Monday, which is likely to lead to his resignation. Japan is also experiencing a similar situation.

U.S. Treasury Secretary Scott Bessenet has talked about the goal of lowering the 10-year U.S. Treasury yield, which would help American citizens more easily secure mortgages or auto loans.

Campbell believes this is a challenging task. He stated, "For the 10-year bond, it is quite difficult to lower the yield to 3%."