The Yield Curve Steepening Trade: Implications of a Potential Trump Presidency and Fed Policy Shifts

The 2024 U.S. election has ushered in a new era of economic policymaking, with Donald Trump's return to the presidency reshaping expectations for Federal Reserve policy and fixed income markets. Trump's reflationary agenda—centered on tax cuts, deregulation, and aggressive trade measures—has already triggered a steepening of the U.S. Treasury yield curve, with long-term yields surging to multi-decade highs. For fixed income investors, this dynamic presents both risks and opportunities, demanding a strategic recalibration of portfolios to navigate the evolving interplay between political priorities and monetary policy.

The Trump Effect: Reflationary Pressures and Inflationary Risks

Trump's policy playbook, including proposed corporate tax cuts and expansive infrastructure spending, is expected to boost economic growth but at the cost of higher inflation. George Brown, Senior U.S. Economist at Schroders, notes that these measures could “make it significantly harder for the Fed to bring inflation to target levels.” The administration's trade policies, including tariffs on imports and renegotiated trade deals, further complicate the inflationary outlook. James Bilson, Fixed Income Strategist, highlights that such protectionism “could exacerbate supply chain bottlenecks and push up input costs for businesses, indirectly fueling price pressures.”

The market has already priced in these risks. Since the election, the 10-year Treasury yield has climbed 16 basis points to 4.449%, while the 30-year yield has surged 19 basis points to 4.641%. The 2-year/10-year yield curve spread now stands at over 100 basis points—more than double its level in 2016—reflecting heightened expectations of inflation and a prolonged period of higher-for-longer rates.

Fed Policy in a Trump Era: A Delicate Balancing Act

The Federal Reserve faces a challenging path in 2025. While Trump's reflationary policies could justify a dovish pivot, the central bank remains constrained by its dual mandate of price stability and maximum employment. Michael Feroli of JPMorgan forecasts one or two rate cuts by year-end, starting as early as September 2025, but emphasizes that “the Fed will likely delay easing until it sees a sustained decline in inflation expectations.”

This cautious approach is evident in the Fed's current policy stance. Despite calls for rate cuts, the federal funds rate remains in the 4.25–4.5% range, with officials wary of undermining inflation credibility. Lisa Hornby, Head of U.S. Fixed Income, observes that “the Fed's reluctance to cut rates prematurely could prolong the steepening of the yield curve, as long-term yields fall in anticipation of future easing.”

Strategic Positioning in Fixed Income Markets

For investors, the steepening yield curve offers a unique opportunity to capitalize on higher long-term yields while managing duration risk. Here are three key strategies:

1. Extend Duration in Long-Dated Treasuries
   With 10- and 30-year Treasuries yielding 4.3–4.5%, investors can lock in attractive income while hedging against inflation. The Bloomberg U.S. Treasury Index has delivered positive total returns year-to-date, driven by coupon income and a steepening curve. However, duration risk remains a concern, as rate cuts later in 2025 could erode capital gains.

2. Diversify into High-Quality Corporate and Securitized Bonds
   Investment-grade corporate bonds and securitized assets (e.g., AAA-rated CLOs, asset-backed securities) offer yields of 4.5–5.5%, outpacing cash and short-term bonds. These instruments provide diversification benefits and resilience during equity market volatility, particularly for issuers with strong balance sheets and limited trade exposure.

3. Hedge Against Policy Uncertainty with Inflation-Linked Securities
   TIPS (Treasury Inflation-Protected Securities) and other inflation-linked bonds can protect portfolios from unexpected price shocks. With one-year CPI swaps now above 3%, the risk of inflation overshooting the Fed's 2% target remains elevated.

Global Context and Structural Trends

The U.S. yield curve steepening is part of a broader global re-pricing of risk. Similar trends are emerging in Germany and Japan, where central banks are shrinking balance sheets and governments are running large fiscal deficits. The global inflationary environment, combined with rising term premiums (the extra yield demanded for holding long-term bonds), has made long-duration assets more attractive.

However, investors must remain vigilant. A potential slowdown in economic growth, driven by trade tensions or a tightening labor market, could reverse the current trajectory. The Fed's projected rate cuts—while providing a floor for long-term yields—may not offset the risks of a “stagflation-lite” scenario.

Conclusion: Navigating the New Normal

The interplay between Trump-era policies and Fed rate expectations has created a complex but navigable landscape for fixed income investors. By extending duration in long-dated Treasuries, diversifying into high-quality corporates, and hedging against inflation, investors can position portfolios to benefit from the steepening yield curve while managing downside risks.

As the Fed prepares for its first rate cut in late 2025, the key will be adaptability. Markets are already pricing in a prolonged period of higher-for-longer rates, but the path forward remains fluid. For those willing to embrace the volatility, the current environment offers a rare opportunity to secure income and capital preservation in an era of shifting political and monetary dynamics.