Tariff Uncertainty Drives 5-Year Treasury Demand, Yields Rise

As the Trump administration's tariff policies continue to cast uncertainty over the Federal Reserve's interest rate trajectory, concerns over U.S. economic growth have intensified. This has sparked a growing trend in the U.S. Treasury market, with investors increasingly favoring five-year Treasury notes as a safe haven.

The period leading up to April 2, the deadline set by President Trump for retaliatory tariffs, has seen a surge in demand for five-year Treasury notes. The cost of purchasing call options on these notes, which bet on rising prices, has reached its highest level since September of last year. This trend is driven by the belief that if the Federal Reserve delays rate cuts due to high inflation, five-year Treasury notes will be the primary beneficiaries. The longer the Fed waits, the more significant the eventual rate cuts will need to be.

In recent months, major institutions have recommended five-year U.S. Treasury notes, citing their unique appeal among different maturities. These notes are seen as relatively resilient to dual risks, unlike two-year notes, which are highly sensitive to Federal Reserve policy, and 10- and 30-year notes, which are more susceptible to concerns about U.S. economic health and rising deficits.

Goldman Sachs has highlighted the balanced safety advantages of five-year Treasuries. Following the latest Federal Reserve meeting, Barclays, Morgan Stanley, and Wells Fargo have also praised the "belly" of the yield curve, referring to the middle section of the curve that includes five-year notes.

As Federal Reserve officials frequently mention policy uncertainty, investors are growing concerned that tariff policies could ultimately drive up inflation, forcing the Fed to remain inactive for a longer period. This sentiment has pushed two-year Treasury yields back up to around 4% from their low point in early March, dampening market confidence in at least two rate cuts this year.

Meanwhile, 10-year Treasury yields have also begun to rise in recent weeks, as deteriorating consumer confidence has raised fears that key U.S. economic data, including the March non-farm payrolls report released on April 4, could also show weakness. In contrast, the volatility in the belly of the yield curve has been relatively stable. Recent options trading indicates that many traders are betting that five-year Treasury yields will fall to around 3.55% by April 25.

The auction of $700 billion in five-year Treasury notes on Wednesday resulted in a final yield of 4.1%, slightly higher than the secondary market level at the 1 p.m. cutoff, indicating that investors demanded higher returns. Despite this, the spread between 30-year and five-year Treasury yields remains the widest since September of last year, as the Congressional Budget Office warned that the federal government could run out of funds as early as August. On Wednesday, most Treasury yields rose by 1-3 basis points, while U.S. stocks fell sharply due to tariff concerns and a tech stock sell-off.