Tariff Concerns Drive 5-Year U.S. Treasury Demand, Yields Rise

As tariff concerns escalate, Wall Street has identified the 5-year U.S. Treasury as the optimal safe-haven asset in the bond market. The impending tariff deadline set by the U.S. President on April 2 has intensified market worries, particularly regarding the trajectory of the Federal Reserve's interest rate policy and the broader economic outlook. This uncertainty has driven a popular trading strategy in the U.S. Treasury market: purchasing 5-year U.S. Treasuries. The option market indicates that traders are inclined to hold positions in 5-year U.S. Treasuries, which are set to mature in five years. This shift reflects a broader trend where investors are seeking stability amidst the economic turbulence caused by tariff concerns.

The 5-year U.S. Treasury is seen as a reliable asset due to its relatively short maturity period, which provides a balance between liquidity and yield. This strategy allows investors to hedge against potential economic downturns while still benefiting from the stability of government-backed securities. The focus on 5-year Treasuries underscores the market's cautious approach to navigating the current economic landscape, where tariff-related risks are a significant factor influencing investment decisions.

Investors are increasingly concerned about whether tariffs will ultimately stimulate inflation, prompting the Federal Reserve to remain on hold, especially as Fed officials cite uncertainty. This concern has led to a rise in the yield of 2-year U.S. Treasuries, which are sensitive to policy changes, from their low point in early March to around 4%. The market has already priced in two rate cuts starting in July. Additionally, the yield on 10-year U.S. Treasuries has also risen in recent weeks due to deteriorating consumer confidence, raising fears of a decline in key economic indicators, including the March non-farm payroll report scheduled for release on April 4.

Meanwhile, the recent trend in options suggests that traders expect the yield on 5-year U.S. Treasuries to drop to around 3.55% by April 25. The 700 billion U.S. dollars of 5-year U.S. Treasuries auctioned on Wednesday had a yield of 4.1%, slightly higher than the market trading price, indicating that investors are demanding higher returns when selling. However, the difference between the yields of 2-year and 30-year U.S. Treasuries is the largest since September of last year, as the Congressional Budget Office warns that the federal government may run out of funds to pay all its bills as early as August. Most U.S. Treasury yields rose 1 to 3 basis points on the day, while U.S. stocks plummeted due to tariff concerns.

In recent months, the 5-year U.S. Treasury has been touted as an attractive public debt on Wall Street, primarily due to its relative resilience to dual risks. In contrast, the 2-year U.S. Treasury is highly sensitive to the Federal Reserve's interest rate policy, while the 10-year and 30-year U.S. Treasuries are more susceptible to concerns about the health of the U.S. economy and the ballooning deficit. Recent reports from major financial institutions, including Goldman Sachs, Barclays, Morgan Stanley, and Wells Fargo, have highlighted the appeal of the so-called "belly of the curve" trade, which involves investing in medium-term Treasuries.

Priya Misra, a portfolio manager at Morgan Stanley, noted that due to rising inflation, the Federal Reserve may delay the start of further rate cuts, making 5-year bonds the biggest beneficiaries. The longer the Fed waits, the more it will need to cut overall interest rates. This analysis underscores the strategic importance of 5-year Treasuries in the current economic environment, where inflationary pressures and policy uncertainty are key factors shaping investment decisions.