Rising T-Bill Supply and Yield Curve Inversion: A Tactical Shift for Fixed-Income Portfolios

The U.S. Treasury's borrowing plans for 2025 reveal a stark reality: surging short-term Treasury bill issuance driven by tax cuts and spending increases is poised to flatten the yield curve, creating risks for traditional bond investors. With deficits projected to balloon to $4.1 trillion by 2034, the Treasury must flood markets with short-term debt, compressing term premiums and pushing investors toward liquidity-focused strategies. This article examines the mechanics of this shift and outlines actionable steps for portfolio reallocation.

The Surge in Short-Term Treasury Supply: A Fiscal Policy Aftermath

The One Big Beautiful Bill Act (OBBBA) and extensions of the 2017 TCJA have created a fiscal reckoning. By 2025, the Treasury expects to borrow $514 billion in Q2 and $554 billion in Q3, assuming an $850 billion end-of-quarter cash balance. These figures reflect a 29.2% year-over-year increase in 2024 issuance, with deficits driven by tax cuts for high earners and corporations, coupled with reduced spending on social programs.

The Congressional Budget Office (CBO) warns that interest costs alone will hit $716 billion by 2034, pushing federal debt to 127% of GDP. This surge in borrowing has direct implications for the yield curve.

Yield Curve Inversion: Cause and Consequence

The yield curve inverts when short-term rates rise above long-term rates—a condition historically signaling recession risks. Today, two forces are accelerating this trend:
1. Fiscal Liquidity Demands: The Treasury's $514 billion Q2 borrowing requires massive short-term paper issuance, increasing supply and depressing prices. With $29.3 trillion in gross Treasury issuance in 2024, the market is already saturated.
2. Fed Rate Path: The Federal Reserve's reluctance to cut rates (despite inflation cooling) keeps short-term rates elevated.

The CBO projects the Fed funds rate will remain above 4.5% through 2026, while long-term yields struggle to rise due to economic uncertainty. This compression of term premiums is already evident: the 2-year/10-year yield spread is -0.6%, its flattest since 2007.

Liquidity Demands and Expert Commentary

The Treasury Borrowing Advisory Committee (TBAC) has issued stark warnings:
> "Debt limit constraints could disrupt efficient financing, amplifying liquidity risks."

With a potential debt ceiling breach looming in Q3 2025, the Treasury may prioritize short-term T-bills over longer maturities, further steepening the front end of the curve. Meanwhile, the Fed's quantitative tightening (QT) is set to conclude in summer 2025, but lingering liquidity shortages will persist.

Cash Allocation Strategies: Positioning for an Inverted Yield Curve

Investors must adapt to this new reality. Here's how:

1. Underweight Long-Dated Bonds

Long-term Treasuries face a triple threat: rising short-term rates, inflation risks, and duration decay. The 30-year Treasury yield, already near 4.5%, could spike further if deficits exceed projections.

2. Embrace Floating-Rate Instruments

Floating-rate notes (FRNs), Treasury Inflation-Protected Securities (TIPS), and short-duration ETFs like SPDR Portfolio Short-Term Treasury ETF (SPTS) offer protection against rising rates. Historical backtesting from 2020 to 2025 reveals that purchasing SPTS on days the Federal Reserve announced a rate cut and holding for 20 trading days resulted in an average return of 3.98%, with a maximum drawdown of just -0.20%. This strategy also significantly outperformed the benchmark, demonstrating strong risk-adjusted performance. These instruments adjust with Fed policy, reducing interest rate risk.

Backtest the performance of SPDR Portfolio Short-Term Treasury ETF (SPTS) when buying on days of Federal Reserve rate decision announcements where a rate cut is announced, and holding for 20 trading days, from 2020 to 2025.

3. Prioritize Liquidity

Allocate a larger portion of fixed-income portfolios to cash or short-term bills (e.g., 3- to 6-month T-bills), which offer +5.25% yields and minimal duration exposure.

4. Monitor Fed Policy Closely

The Fed's 2025 rate cuts, if delayed beyond expectations, could push the yield curve deeper into inversion. Investors should use Fed funds futures () to time entry/exit points for duration-sensitive assets.

Conclusion: Act Before the Curve Breaks

The Treasury's short-term issuance surge and Fed policy gridlock are setting the stage for a prolonged inverted yield curve. Investors who cling to long-dated bonds risk capital erosion. The path forward is clear: reduce exposure to duration, favor floating-rate instruments, and prioritize liquidity. With deficits on track to hit $21.1 trillion by 2034, the time to act is now.

Gary Alexander is a pseudonymous financial analyst specializing in fixed-income markets and macroeconomic trends. His work focuses on actionable insights for retail and institutional investors.