Anatomy of a US Treasury Sell-Off

These Treasuries wind up on dealer balance sheets. We see repo rates inch higher as a way to reflect that lack of buyers in the market. We do not think the unwind of the basis trade contributed to the sell-off, but it certainly was a factor once momentum had begun.

Reason number two is tariffs. We don't know quite the magnitude or the extent of the tariffs, but we do know that tariffs will contribute to inflation in 2025. And this is making investors nervous. We also know the Federal Reserve has commented that they are worried about tariffs and the inflationary impact. And that they might be hesitant to reduce interest rates.

Factor number three are the fiscal concerns. They're intensifying as the budget-reconciliation blueprint progresses through Congress. Rumored additional deficit worries are spooking the bond market and investors and are causing additional pressure on the term premium, especially out to 30 years.

Factor four, foreign investor divestment. Secretary Bessent recently confirmed that there was no evidence of foreign selling of US Treasuries in April. We're going to put this more in the rumor right now more so than the fact category, but it is something to keep an eye on as we roll through this global tariff war.

This is no time to panic on duration. We have low visibility into what tariff rates will be, what countries they will affect, and what industries will be impacted.

What we do believe is that all of this uncertainty—and tariffs themselves—are going to cause a dramatic slowing in US economic growth. This dramatic slowdown will impact the jobs market, and eventually the Federal Reserve will be forced to cut interest rates, we think three to four times this year. This monetary easing should be supportive of the bond market, especially for bonds maturing in less than 10 years.

It's imperative that we closely monitor the US fiscal situation. The reconciliation bill is making its way through Congress. We have insight that it should be completed by the beginning of June. We do expect the budget deficit to be around 6%, which we think is well in line with market expectations and should be supportive for the bond market.

We expect the upcoming auction of Treasury bonds to be well received by both US and international investors. Clients should expect the Fed to support the bond market if there are signs of distress. So far, we have seen periods of some lower liquidity where bid-asks have widened, but overall, no systemic problems, no real stress in the Treasury market. We believe there is zero probability of a US Treasury default centered around the debt-ceiling debate.

Given this outlook, we're focused on three ways to manage duration risk.

Stay active. We strongly believe that Treasuries will exhibit negative correlations for when risk assets come under duress. Volatility remains high, which will create opportunities to both buy and sell. Currently, with yields around 4.5%, we think this is a good entry point for duration.

We maintain our belief that the US economy will decelerate and that will cause the Federal Reserve to reduce interest rates. This tends to be a good environment for curve steepeners, and investors should consider adding positions at the front end of the curve.

One silver lining is that Treasury Secretary Scott Bessent is keenly focused on funding costs and term premium in the bond market. While structural pressures are building, this level of attention by policymakers should act as a potential buffer and helps to anchor investor expectations around duration.