Treasury Yields Decline Amid Fed Policy Uncertainty, Fiscal Concerns

U.S. Treasury yields have continued to decline, facing pressure from both ends of the yield curve. This downward trend is attributed to the Federal Reserve's intention to maintain a restrictive policy stance and fiscal concerns that are impacting the outlook for bond issuance.

Neel Kashkari, the president of the Minneapolis Federal Reserve, cautioned investors that the Federal Reserve may pause for an extended period during an easing cycle. In a statement on Monday, he suggested that September could be the earliest date for the next rate cut, but he expressed uncertainty about the clarity of the situation at that time. Given that derivatives traders anticipate a 75% chance of a rate cut at the September meeting, Kashkari's remarks underscore the short-term risks facing U.S. Treasuries.

Long-term U.S. Treasuries remain susceptible to the impact of the Trump tax reform, which could exacerbate investor concerns about the U.S. debt burden. If the Senate's hardliners push for further spending cuts, these concerns might be alleviated to some extent. However, the current situation suggests that the tax reform is likely to significantly increase the already substantial budget deficit.

Investors appear to have paid little attention to the reassurances made by Treasury Secretary Steven Mnuchin at the end of last week. The 30-year Treasury yield remained steady at 5.04% on that day. Mnuchin discussed the possibility of reforming the supplementary leverage ratio (SLR) rules, which could make it easier for banks to purchase U.S. Treasuries. However, this did not provide any boost to Treasury yields, despite his assertion that such adjustments could significantly lower yields.

Following these comments, the extremely inverted long-term Treasury yield curve did narrow slightly, but by the end of the day, it had returned to the level it was at before the Treasury Secretary raised the issue. Martin Whetton of Westpac Bank suggested that this could be due to the market realizing that any such adjustments would take several months to implement.