(Bloomberg) — A key Treasury yield gap has shrunk to its tightest level in a year as traders ramp up bets the Federal Reserve may keep interest rates higher for longer under new chairman Kevin Warsh.
The spread between five-year and 30-year yields — a closely watched gauge of the premium investors demand for holding longer-dated debt — has narrowed to about 81 basis points, the lowest since May 2025.
The move is driven mainly by a selloff in shorter-dated Treasuries, which are more sensitive to shifts in Fed policy expectations. The gap between two- and 30-year yields has also narrowed to its tightest since July as of Friday’s close.
Investors are increasingly expecting that the Fed will need to tighten monetary policy this year after the Iran war spurred the biggest inflation surge since 2023, prompting a number of officials to abandon their easing bias. President Donald Trump — who has repeatedly pressured the Fed to cut rates — said on Friday he wanted Warsh to lead the central bank independently.
“The data and the politics are suggesting less pressure for rate cuts, and short end yields have been repricing higher,” said Andrew Ticehurst, senior strategist at Nomura Holdings Inc. Trump’s comments about letting Warsh do his “own thing” are also helping, he added.
The flattening yield curve comes as traders debate whether inflation risks or an economic downturn will ultimately dominate the outlook for the world’s biggest bond market. The stakes are high because US Treasuries serve as the benchmark for global borrowing costs, influencing everything from Japanese government bonds to European and emerging market debt.
Fed Governor Christopher Waller — a Trump appointee who previously advocated rate cuts to protect the labor market — said last week the central bank’s next move is now just as likely to be a hike.
Wall Street also sees borrowing costs going higher. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said rates may climb much further. The views from strategists at ING Bank NV, Goldman Sachs Group Inc. and Barclays Plc suggest the jump in some long-term yields may not fully reverse even if inflation driven by higher oil prices eases, thanks to factors such as already large public debt burdens and the fallout from the AI investment boom.
Oil prices retreated Monday on optimism over a US-Iran deal to reopen the Strait of Hormuz. Trump said that negotiations were “proceeding nicely.”
Tracy Chen, portfolio manager at Brandywine Global Investment Management, said the so-called “bond vigilantes” are warning central banks that they are falling behind the curve.
“Even if we get some relief on oil prices, I don’t think the developed market bond selloff structurally will just stop here,” Chen said in a Bloomberg TV interview on Monday.
She estimates that 10-year yields could eventually rise toward 5%, and some maturities potentially even 5.5% to 6% over time, driven by structural factors including loose fiscal policy, heavy defense and AI infrastructure spending, aging demographics and geopolitical turmoil.
What Bloomberg Strategists Say…
“Inflation accelerating globally means the Fed and other major central banks are primed to remain hawkish, hurting the outlook for the short end, while bonds further out the curve stand to benefit as signs emerge of a severe hit to the global growth outlook.”
Garfield Reynolds, Markets Live strategist
Yields on five-year Treasuries climbed to this year’s high of 4.35% last week and were last at 4.26% on Friday. Those on 30-year Treasuries slipped to 5.06%, down from this year’s peak of around 5.20%, as oil prices retreated. Benchmark 10-year yields were at 4.56%. Cash trading was closed Monday for a US holiday.
Traders are now pricing in that the Fed is virtually certain to start raising rates by December, a reversal from before the Iran war when markets had expected two quarter-point rate cuts.
“There are so many things that the bond market has to worry about that. The conflict in this region is only part of the story,” said Steven Major, global macro adviser at broker Tradition Dubai. “The bond market is anything but stable and is becoming a bit unpredictable, which I think explains these elevated yields.”
–With assistance from Avril Hong.
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