Inflation Chill: Why Intermediate Treasuries Are Poised for a Rally

The May 2025 New York Fed Survey of Consumer Expectations delivered a stark message: Americans are cooling on inflation. Short-term inflation expectations dropped to 3.2%, the lowest since late 2021, while long-term forecasts fell to 2.6%, near pre-pandemic norms. This decline, paired with reduced uncertainty metrics and improved household financial perceptions, points to a pivotal shift in market psychology—one that could fuel a bond market rally, especially in intermediate Treasuries.

The Inflation Narrative Is Flipping

The survey's findings are unequivocal. Consumers now anticipate slower price increases across key categories: gas (-0.8pp), medical care (-1.3pp), college education (-1.6pp), and rent (-0.6pp). Even food prices, which rose slightly, remain below 2022 peaks. Crucially, inflation uncertainty—a gauge of disagreement among respondents—dropped at the one-year horizon, suggesting less fear of runaway costs.

This shift matters because inflation expectations are a leading indicator for bond yields. When households and businesses believe prices will stabilize, they demand lower compensation for inflation risk, driving bond prices higher. The 10-year Treasury yield, for instance, has already fallen from 4.7% in April to 4.4% this month, a move consistent with easing inflation fears.

The Yield Curve's Silent Signal

The Treasury market is pricing in a calmer economic future. The 2s10s yield spread—the gap between 2- and 10-year Treasuries—narrowed to just 0.47% this week, a stark contrast to its -2.41% trough in 1980 and its inversion streak between 2022–2024. .

A flattening curve typically signals that investors expect the Fed to stop hiking rates—and maybe even cut them. With the Fed's terminal rate now likely capped at 4.0%, the urgency to price in further hikes has faded. This benefits intermediate Treasuries (5–10 years), which have historically thrived in flattening environments. Their duration isn't long enough to fear rate spikes but is long enough to capture yield improvements as short-end rates stabilize.

Why 5–10 Year Treasuries Are the Sweet Spot

The data supports this thesis. . Intermediate maturities have outperformed both short-term bills (which face liquidity risks as the Fed shrinks its balance sheet) and long-term bonds (which remain sensitive to fiscal deficits and geopolitical risks).

Consider the math: A 10-year Treasury yielding 4.4% offers a 0.37% premium over the 2-year note. That spread is narrow by historical standards but still attractive given the reduced risk of a Fed tantrum. Meanwhile, the 5-year yield at 4.0% provides a middle-ground return with lower price sensitivity than 30-year bonds, which now yield 4.95% but face headwinds from rising supply.

Risks and Reality Checks

Skeptics will point to lingering threats: a $3.5 trillion deficit, China's slowing growth, and the Fed's stubbornly hawkish rhetoric. Yet markets are forward-looking. The NY Fed survey's most telling sign is the 14.8% drop in perceived job-loss risk—the lowest since 2020—suggesting households feel secure enough to rebalance portfolios.

If the Fed pivots to rate cuts in 2026, as futures markets now price in, intermediate Treasuries will benefit doubly: from falling short rates and a steepening curve. Even without Fed action, the fading tail risk of hyperinflation means bonds are now a safer bet than they've been in years.

The Bottom Line: Buy the Dip in 5–10 Year Treasuries

Investors should treat the recent Treasury selloff—a 10-year yield spike to 4.7% in April—as a buying opportunity. The May survey data, combined with the flattening yield curve, suggests a technical sweet spot for intermediate maturities.

• Trade Idea: Overweight 5–10 year Treasuries via ETFs like IEF or TLT (though TLT's duration may be too long).
• Avoid: Short-term bills, which offer little yield cushion, and 30-year bonds, which face supply headwinds.
• Watch: The 2s10s spread. If it turns negative again, it could signal renewed recession fears—but right now, the flattening trend is a bullish sign.

Inflation is cooling, the Fed is done hiking, and consumers are breathing easier. For bond markets, this is the setup for a rally—not a crash.