Freedom Broker experts named the main threats to U.S. government bonds

Freedom Broker analysts believe that the main risks for long-term U.S. Treasury bonds right now are geopolitical tensions around the Strait of Hormuz, the country’s budget deficit, and uncertainty in the Fed’s communication, rather than a possible rate hike. Therefore, the experts maintain a restrained stance toward interest-rate risk on the long end of the debt market.

The U.S. Treasury market includes U.S. government debt securities with different maturities. Their yields react to expectations for the Fed rate, inflation, the state of the economy, the budget, and geopolitical risks.

Rate hike is already priced into yields

The futures market estimates the probability of a 25-basis-point Fed rate hike at the September 16 meeting at about 58%. The expected rate is 3.78% versus the current effective federal funds rate of 3.63%.

At the same time, the Treasury yield curve already reflects about 50 basis points of rate increases over the next two years. According to Freedom Broker analysts, any potential policy tightening will be targeted and limited to one or two hikes, without turning into a prolonged cycle.

In this scenario, a rate hike could lead to a flattening of the curve and stabilization of long-term yields. Short-term bond yields may rise further, but the analysts expect the move to be moderate.

Long-term bonds are under different pressure

Freedom Broker notes that since June the inflation component of ten-year yields has been declining. The main contribution to the rise in their nominal yield came from an increase in the real rate.

Without accounting for geopolitics, fiscal risks, and a possible decline in the transparency of the Fed’s communication, both short- and long-term Treasuries would look attractive to buy. However, the combined impact of these factors remains too difficult to forecast, so the analysts continue to assess the long end of the curve cautiously.

Ten-year yield rose to 4.78%

Over the week from August 28 to September 4, the yield on two-year Treasuries increased from 4.35% to 4.37%, or by 2 basis points. The yield on five-year notes was almost unchanged at 4.31%.

The yield on ten-year Treasuries rose from 4.72% to 4.78%, or by 6 basis points, and the thirty-year yield rose to 5.24%. The spread between ten-year and two-year yields widened by 4 basis points, to 42 basis points.

The strongest pressure on bonds was observed at the beginning of the week after reports of an escalation of the conflict in the Middle East. Strong labor-market data on Friday triggered a sharp rise in yields, but they then returned close to previous levels, so the overall effect of the statistics was insignificant.

Inflation will clarify the Fed’s decision

During the week of September 7–11, investors will watch for the release of producer and consumer price indexes. PPI will be released on Thursday, and the key indicator of the week—CPI—on Friday. These data should provide additional clarity on the prospects for a rate hike at the Fed meeting.

Treasury auctions will also take place: $58 bn of three-year notes, $39 bn of ten-year notes, and $22 bn of thirty-year bonds. Previous offerings of long-term issues were generally stable, which indicates there has been no noticeable decline in demand.

Not an individual investment recommendation.