R. Seelaus & Co.: Market Commentary from our COO, Ben Seelaus

Summary

The yield curve has dramatically steepened this year but it does not mean it can’t be steeper. We are in a new paradigm where past market precedent and technicals may not hold true this time around due to unprecedented Federal approach, initiatives and policies.

Backdrop

This week, the 2/30s curve in the US is trading above 132bps which marks the steepest levels of the year and a breakout of the recent range.  There are many reasons why this has been a trend in the rates market this year, but the question when anything hits a high or breaks out is – can it continue?  In looking at the overall macro backdrop and outlook for the markets from here, seems as though the answer is yes.

As you can see from the table below, the yield curve has really been a tale of two stories, the front-end has rallied sharply while the bond has sold off:

 

*Source:  Bloomberg (YTD Levels spotted on 9/2)

If anyone polled market participants, the rally in short dated yields and the recovery in the stock market are pretty simple to explain.  Despite the current friendly environment, growth is expected to slow in the second half of the year, concerns over the impact of tariffs on the broader economy persist and the Fed has indicated that policy is more restrictive than neutral.  All of that has resulted in the market pricing in a Fed rate cut later this month and potentially more to come over the balance of 2025 and into 2026.  In turn, the prospect of easier monetary policy has kept volatility low and buoyed risk assets. 

The more nuanced question and the more important question long term is: why has the long bond not only refused to rally, but sold off ~20bps this year?

I would argue there are four big policy initiatives that have impacted markets the most.  In no particular order, those are :  DOGE and government spending cuts, tariffs, the Big Beautiful Bill and discussions around the FOMC.  Let’s analyze each of these individually and then try to highlight some themes and draw conclusions.

DOGE

I would argue there was no singular acronym that garnered more media attention and focus just after the election than DOGE.  Elon Musk and his team burst into Washington with the goal to cut over $2 trillion in federal spending.  After some splashy moves to start (think closing USAID), DOGE lost some momentum, and the dollar amounts actually cut are estimated to be closer to $150bn.  While a $150bn reduction in federal spending is nothing to sniff at, DOGE falling short of its goals is more important when taken into context with the passage of the big, beautiful bill.  DOGE was to be the ballast against any implied deficit increasing measures passed later by the administration and the idea that it was less significant than hoped matters more when we look at the other three initiatives.

Tariffs
For all the fanfare and headlines of 2025, I do not think any singular trading session or week holds a candle to Liberation Day.  The sweeping tariffs announced by the administration that day caught the market by surprise causing a steep drop in equities and fixed income and a spike in volatility.

The funny thing for me about current tariff policy is that no one is quite sure what it means for the US and by extension, the global economy.  Economists who are against the move say tariffs will be inflationary or a tax on growth.  Those who argue for the policy believe that it is the key to onshoring US manufacturing and will ultimately lead to a long-term expansion for the domestic economy.  

This uncertainty has caused the US yield curve to steepen for a couple reasons.  The traditional concern over tariffs has been the potential that they will restrict economic growth in the short term while also increasing inflation.  By extension, this implies that the fed may cut rates to counteract slower growth and employment as the US economy adjusts.  However, the idea that this may happen while inflation persists can call into question central bank credibility and lead to increased risk premium at the longer end of the curve.

Speaking of increased risk premium, I think this is the most significant after effect of Liberation Day.  That day in the Rose Garden was the first time the markets were put on notice that Trump and his administration had a plan that they were going to enact regardless of what political traditions or norms dictated.  The actual tariff policy itself matters a lot less than the sweeping nature and penal levels which caught the markets by surprise.  The broader implication was that significant change was on the horizon and everyone should be prepared.  To that end, longer dated assets need to adjust and price in additional compensation for investors unsure of what may come next. 

Interestingly, when I was looking at where everything traded just before Liberation Day, I noticed that the 30yr UST yielded 4.41% on the Friday, 4/1 ahead of the announcement.  At that point in the year, the curve had already begun to marginally steepen but all yields were significantly lower than where they started 2025 and the bond was no different.  Since that date though – the bond has only closed one session within 25bps of 4.41% and that was on April 29^th when it closed 4.65%.  Despite fixed income as an asset class broadly rallying, the bond has had no ability to find a bid or recover and as mentioned earlier has sold off to adjust for future uncertainty.  To put that in context, 2yr yields are now 80bps lower on the year and 30bps lower than the local highs in early April. 

The Big, Beautiful Bill
Currently, the CBO estimates that the bill will add over $3 trillion to the US deficits.  Although the administration disputes this and argues it will reduce the deficit, it seems markets were prepared for Trump to be a little more aggressive in explicitly attacking the deficit rather than trying to grow out of it.  This, combined with a more limited scope of DOGE, increases pressure on long-dated yields as structural deficits continue to be a significant issue for the US.

Jerome Powell, Stephen Miran, Lisa Cook and a Lower Fed Funds Rate
One of the other pervasive story lines of late is the Fed.  Not just fed policy and the outlook for policy going forward, but the Trump administration’s view on the fed funds rate (needs to be lower) and their desire to have a different makeup of the FOMC.  Whether its public pressure on Powell to lower rates, the appointment of Miran to join the committee or the campaign to remove Cook, it is clear that Trump wants a lower fed funds rate. 

The discourse around the Fed is important on two levels.  First, it is clear that dovish policy will be delivered – its just a question of when.  Secondly, the discussion about the makeup of the FOMC, and potential changes, have resulted in questions around the independence of the committee.  Both of those forces argue for steeper curves on the margin, the first from a macroeconomic perspective and the second from a risk premium perspective.  The idea that Fed independence is getting questioned in the market will likely result in a demand for increased compensation from the investing community for nominal US government bonds.

Conclusions

The US economy has held up better in the short run than many had forecast when tariffs were initially announced.  Although there were some downward revisions to the payroll data, that is not uncommon and probably does not materially leave the US in a different place than previously thought.  Inflation has stayed toward the higher end of the fed’s preferred range, although it has not jumped to levels consistent with the shocks that some forecasted.  This is not to say that growth will not slow and inflation will not spike, they both may or may not, but neither has materialized to date.  Risk appetite remains high, asset prices remain at, or near, record valuations and volatility remains subdued.

If I step back and combine everything that I’ve written so far, a few themes emerge.  The first is that more dovish domestic policy is on the horizon and will likely keep coming.  The aforementioned payroll revisions have opened the door for Powell to move rates back to levels he feels are “neutral” and it seems likely that future fed appointees are likely to espouse more aggressively dovish policy in the future. That means the front-end of the US curve should remain anchored in a base case and be poised to rally further in a more dovish scenario.

The long-end is an entirely different story.  The combination of uncertainty around short term price pressures combined with increased fiscal spending and the potential for easier monetary policy, all taken in the context of equity markets at their all time high and ample liquidity in the system, should be enough to wake the old bond vigilantes from their graves.  If you add in discussions around the independence of the fed and the unpredictability of the next Trump move, the need for increased risk premium all the way across the board becomes immediately apparent. 

The one caveat that I will mention is that higher 30yr yields and the potential for higher 10yr yields should scare policy makers on all sides of the aisle.  The US economy is built on borrowing, whether it be corporate issuance, home mortgages or consumer debt.  In this day and age, many of those rates have a lot less to do with fed funds as a benchmark and a lot more to do with the current 10yr yield.  The only thing to my mind that could pin long rates lower than they currently sit would be a good, old fashioned recession… but no one is rooting for that.  And even in that scenario, should the fed be aggressive, one could argue the curve stays steep.

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Past performance is not indicative of future results. Future market conditions are uncertain, and actual outcomes may differ materially from any forward-looking statements contained herein.

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