US Treasury bonds plummet like in 1995, traders believe in a soft landing

The last time US government bonds experienced such a significant sell-off due to the Federal Reserve starting to cut interest rates, Alan Greenspan was planning a rare soft landing.

Since the Fed's first rate cut on September 18, 2020, the two-year Treasury yield has risen by 34 basis points. In 1995, under Greenspan's leadership, the Fed successfully cooled the economy without causing a recession, and a similar rise in yields occurred at that time. In previous rate-cut cycles before 1989, the two-year Treasury yield typically fell by an average of 15 basis points one month after the Fed started cutting rates.

The recent sell-off in US Treasuries is similar to the situation after the Fed's rate cut in 1995.

Steven Zeng, interest rate strategist at Deutsche Bank, said that the rise in yields "reflects a reduced likelihood of economic recession risk." "The data is quite strong. The Fed may slow down the pace of rate cuts."

The latest rebound in yields indicates that the resilience of the US economy and the prosperity of financial markets have limited Fed Chairman Powell's active rate-cutting choices. Rate swap trading shows that traders expect the Fed to cut rates by 128 basis points by September 2025, compared to 195 basis points a month ago.

As investors weigh the possibility of a slowdown in rate cuts, global bond yields continued to decline this week, leading to a total return on US Treasuries measured by an index rising by only 1.7% as of this Monday, lagging behind the 4.3% increase over the same period. The recent rise has pushed the yield on the 10-year benchmark Treasury from a 15-month low of 3.6% on September 17 to around 4.2%, the day before the Fed announced a 50 basis point rate cut on September 17.

Tuesday's trading activity indicated that market sentiment remains bearish, with a series of large sell trades in 10-year Treasury futures. In the options market, there was a trade targeting a rise to around 4.75% in the yield on 10-year Treasuries by the expiration of the November 22 options.

In 1995, after a significant increase in interest rates, the Fed cut rates three times within six months—from 6% to 5.25%. After the first rate cut that year, the yield on the 10-year Treasury rose by over 100 basis points after 12 months, while the two-year Treasury yield rose by 90 basis points.

This time, the rise in yields also reflects growing concerns that the Republican Party may control the White House and Congress in the November 5 election, potentially increasing the federal deficit and inflation. Volatility has also increased. The ICE BofA Move Index, which tracks the expected volatility of US Treasury bonds in the next month, has risen to its highest level this year