Steeper Curves Ahead

Following a softer July jobs report, markets are now fully pricing in a September Fed rate cut and additional easing through 2026. Despite no longer being inverted, the 3-month/10-year and 2-year/10-year Treasury yield curves remain historically flat. This anticipated monetary easing is expected to lead to a significant yield curve steepening, as short-term rates are projected to decline faster than long-term rates, consistent with historical patterns during Fed rate cut cycles, even within a projected slow-growth, above-2% inflation environment.

Analysis

Following a softer-than-expected July jobs report, fixed income markets have fully priced in a Federal Reserve rate cut for the September FOMC meeting, with expectations for additional easing extending through 2026. While the primary Treasury yield curves—the 3-month/10-year and 2-year/10-year spreads—are no longer inverted, they remain historically flat at +9 basis points and +56 basis points, respectively. The divergence in their year-to-date performance, with the 3-month/10-year spread flattening while the 2-year/10-year has steepened by approximately 25 bps, reflects the Fed's current policy inaction; the 3-month T-bill yield remains anchored to the high Fed Funds rate, whereas the 2-year yield has begun to price in future cuts. Based on historical precedent from every Fed cutting cycle over the last 35 years, a significant yield curve steepening is anticipated once easing begins. The base-case scenario projects a 'bull steepener,' where short-term yields fall in line with Fed cuts, while the 10-year Treasury yield remains relatively contained within a 4.00% to 4.75% range amid slow economic growth and inflation persisting above the Fed's 2% target.

Key Decisions for Investors

• Investors should consider positioning for a yield curve steepening, as analysis suggests this is the most probable outcome once the Federal Reserve commences its anticipated rate-cutting cycle.
• It may be prudent to overweight exposure to the front-end of the Treasury curve, as short-term rates are expected to fall more significantly than long-term rates, offering greater potential for price appreciation.
• Exercise caution with long-duration assets, given the forecast that persistent inflation and slow growth will likely keep the 10-year Treasury yield range-bound between 4.00% and 4.75%, limiting upside potential.