The Yield Curve's Quiet Turn: Why Long-Term Bonds and MBS Offer Shelter in a Volatile Summer

The U.S. Treasury market has been a battleground of competing narratives in June 2025. While Treasury Secretary Scott Bessent has staked his credibility on the administration's fiscal policies—touting “very tame” inflation and the promise of trade deals—the bond market has been skeptical, driving the 10-year yield to nearly 4.58%. Yet beneath the noise, a confluence of factors suggests a parallel downward shift in the yield curve is brewing, creating opportunities in long-duration bonds and mortgage-backed securities (MBS). Here's why investors should position for this shift—and where to tread carefully.

The Case for a Yield Curve Decline

1. Fiscal Policy and Inflation: Bessent's “Tame” Data

Bessent's confidence rests on two pillars: subdued inflation and the “One Big Beautiful Bill Act.” The May CPI reading of 2.4% YoY, with energy prices down 20% year-over-year, has provided cover for his argument that price pressures are contained. Even critics acknowledge that shelter and food inflation have cooled, and wage growth, while steady, isn't spiking.

This data pair shows how yields have historically tracked inflation expectations. With core CPI near the Fed's 2% target, the case for a downward yield shift grows stronger.

2. Trade Deals and Policy Certainty

The Treasury's June FX Report highlighted China's trade surpluses and an undervalued yuan, but Bessent's optimism about resolving these imbalances through diplomacy—not tariffs—suggests a softening of trade tensions. The July 9 deadline for trade negotiations with China and the U.S.-UK deal (projected to deliver $5B in exports) could reduce uncertainty. A resolution here would ease the risk premium embedded in bond yields.

3. The Fed's Hidden Hand

The Fed's June decision to hold rates steady, despite inflation below 3%, hints at a dovish pivot. The SEP's “one rate cut by year-end” is likely conservative. If trade deals avert a tariff-driven inflation spike, the Fed could cut rates more aggressively in Q4, flattening the yield curve.

Opportunities: Long-Duration Bonds and MBS

Long-Term Treasuries: The Safe Harbor

The 30-year Treasury bond (Trea30Y) is poised to benefit from a yield decline. Its duration sensitivity means even small rate cuts could deliver outsized returns. Consider: a 0.5% drop in yields would generate a 12-14% capital gain for a 30-year bond yielding 4.5%.

Past easing cycles show long-dated Treasuries thrive when the Fed cuts rates.

MBS: Capturing the Spread Compression

MBS spreads over Treasuries have widened to 150-200 bps due to prepayment fears and liquidity concerns. However, if rates stabilize or decline, these spreads will narrow, boosting MBS prices. Fannie Mae and Freddie Mac securities, in particular, offer attractive yields (4.8-5.2%) with government guarantees.

The widening gap suggests a reversion-to-mean opportunity as policy clarity emerges.

The Tariff Trap: Post-July Risks

While the July 9 deadline is a critical catalyst, failure to secure trade deals could reignite volatility. A tariff reinstatement would spike energy and industrial goods prices, forcing the Fed to delay cuts. In this scenario, short-term Treasuries (e.g., 2-year notes) and inflation-linked bonds (TIPS) would outperform.

Investment Strategy

1. Buy Long-Term Treasuries: Allocate 30-40% of a fixed-income portfolio to 10- or 30-year Treasuries. Use futures or ETFs like TLT to gain exposure.
2. Add MBS Exposure: Target MBS ETFs (e.g., MBG) or agency pass-through securities. Monitor spreads for compression opportunities.
3. Hedge with Volatility Tools: Pair long-duration bets with Treasury put options or inverse rate ETFs (e.g., TBF) to cushion against a tariff-driven spike.
4. Stay Short-Term Post-July: If trade talks fail, pivot to 2-year notes and TIPS.

Conclusion

The Treasury market's recent turbulence masks a compelling opportunity: a downward yield shift is coming, driven by Bessent's fiscal confidence, low inflation, and trade deal optimism. Long bonds and MBS are the vehicles to capture this move, but investors must remain agile post-July 9. The Fed's next move—and the fate of tariffs—will determine whether this shift becomes a sustained rally or a fleeting dip.

Final Note: Monitor the 10-year yield's behavior post-July. A break below 4.2% would confirm the downward trend; a breach of 4.7% signals a return to volatility. Stay nimble.