The U.S. Treasury market in 2025 is navigating a delicate balance, with tariff-induced volatility, Fed rate expectations, and structural changes shaping views. Historically, U.S. Treasuries have served as a hedge during economic downturns, with yields falling as investors seek safety. However, long-term bonds (10-year and 30-year) have underperformed recently, as their yields reflect higher term premiums rather than declining risk.  

Although volatility in the U.S. Treasury market has subsided in recent weeks, with the MOVE index down about 18% from its peak of 139.87, jitters remain. That said, the market still remains a viable tool to protect portfolios during economic and tariff-driven uncertainty. But direct purchases of government bonds, especially long-term ones, may not offer the traditional safe-haven benefits. Recent market dynamics suggest a more nuanced approach. 

The economy faces potential tariff-induced inflation, slowing growth, and employment risks. Two key factors are shaping the yield curve: a repricing of the term premium and shifting monetary policy expectations. Recent events have increased the term premium—the premium investors demand for holding long-term debt—across the yield curve. Prolonged uncertainty could further elevate this premium, raising yields at the long end (e.g., 30-year) relative to the short end. 

On the policy side, with growth projected to weaken in 2025 and inflation expectations elevated, the Federal Reserve’s ability to adjust interest rates is constrained until expectations stabilize. This anchors shorter-term yields (e.g., 5-year and below) compared to longer-term yields. 

Yield Curve Dynamics 

A 5-year/30-year curve steepener trade is a sophisticated way to position for these dynamics. This strategy involves selling 5-year Treasury yields to bet on their relative stability and buying 30-year Treasury yields to capitalize on rising long-end yields. One can use Treasury futures or exchange-traded funds (ETFs) to create a dollar-neutral position, ensuring equal notional exposure to the 5-year and 30-year legs. 

The goal is to profit from a widening spread, which is currently trading around 86 basis points, between the two securities, and is well-suited for a stagflationary environment of rising inflation and sluggish growth. With the spread pulling back from its weekly high of around 96 basis points, the current level may offer an opportunity to enter the trade. The approach leverages the term premium’s behavior, offering a way to navigate uncertainty while mitigating downside risks.  

How Can the Spread Widen? 

Yields rise across the curve: If inflation accelerates due to tariffs, both 5-year and 30-year yields may increase, but the 30-year yield is likely to rise faster due to its sensitivity to term premium and inflation expectations.  

Curve twist: In a stagflationary environment, the 5-year yield could remain anchored (due to Fed policy) while the 30-year yield climbs, reflecting inflation and uncertainty. 

Yields fall with differential impact: If the economy tips into recession, long-end yields may fall significantly as investors flock to safe-haven bonds, narrowing the spread. However, even in this scenario, the trade could remain viable if the 5-year yield declines more than the 30-year yield, preserving the spread’s widening. 

Risks to Trade 

Unexpected Fed rate cuts could compress yields across the curve, reducing the spread, or a swift resolution to tariff disputes could lower inflation expectations, stabilize long-end yields and limit spread widening. 

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