How June's bond rally might give way to a round of volatility in Treasury bills

The recent bond rally, driven by expectations of Fed rate cuts, faces potential volatility in July, particularly in Treasury bills. A proposed $3.3 trillion tax bill from former President Trump, favoring short-term T-bill issuance, threatens to flood the market with new supply. Strategists, including LPL Financial's Lawrence Gillum, warn that the market may struggle to absorb this volume, potentially driving short-term yields higher and disrupting the front end of the curve, even as longer-dated yields might find relief. This scenario, coupled with the alternative risk of a debt ceiling crisis if the bill fails, suggests a potentially choppy period for the Treasury market.

Analysis

A recent rally in long-duration U.S. government bonds, which pushed the 30-year yield below 5% in June, is now facing a significant counter-pressure from potential fiscal policy changes that could introduce volatility into short-term debt markets. The primary catalyst is a proposed bill from former President Trump, which the Congressional Budget Office estimates could add nearly $3.3 trillion to the national deficit between 2025 and 2034. Critically, President Trump has expressed a strong preference for financing this deficit with Treasury bills maturing in a year or less, potentially overwhelming the market with short-term supply. Strategists like Lawrence Gillum of LPL Financial warn that market participants may "balk" at absorbing this volume, which could disrupt the front end of the curve and push short-term yields higher, even as longer-dated Treasury yields might decline. This dynamic is compounded by the alternative risk; should the bill fail, the market would pivot to facing a potential U.S. debt ceiling crisis in August. This dual-threat scenario suggests a "choppy period" ahead for the Treasury market, with risks heavily concentrated in T-bills and the potential for significant yield curve movements.

Key Decisions for Investors

• Consider positioning for a potential yield curve steepening by evaluating long positions in longer-dated Treasurys against cautious or short positions in short-term T-bills.
• Investors should monitor the legislative progress of the proposed fiscal bill and statements regarding the debt ceiling, as these events are the primary catalysts for the anticipated volatility.
• It may be prudent to hedge against a spike in short-term interest rate volatility, particularly for portfolios with heavy allocations to cash equivalents like T-bills.
• Reassess money market and short-duration fund allocations to mitigate potential price disruption from a sudden influx of Treasury bill supply.