United States
The recent Treasury sell-off displays signs of reduced liquidity and shows signs of some market dysfunction. However, we believe fixed income remains attractive, although investors may need to embrace uncertainty.
A “queasy” run for long-dated Treasuries
Figure 1: Sharp rise in Treasury yields prompts tariff delay1
The move appeared to be a major factor in the administration’s decision to pause most tariffs for 90 days2, with the President noting “queasy” bond markets. However, after initial relief, Treasury market volatility continued. We see three reasons for the sell-off.
1) A dash for cash
Memories of recent Treasury liquidity squeezes appeared to spur demand for cash and cash-like assets. This may have included some selling of longer-dated Treasuries.
2) Anticipation of lower foreign demand
Less imports implies fewer US dollars circulating in foreign economies, where they might be invested in US Treasuries.
Foreign investors currently account for ~30% of all US Treasury holders, albeit their holdings are mostly concentrated at maturities below 5-years3. Speculation of retaliatory “dumping” seems unlikely to us, but expectations of lower foreign Treasury demand probably contributed to sell-off, whether it involved significant foreign sales or not.
3) Rising inflation and term risk premia
The sell-off at longer maturities (Figure 2) may reflect greater inflation and growth (i.e. stagflation) concerns. It may also reflect potential repricing of the fiscal policy outlook. Proposed congressional budget resolutions may have raised doubts about the administration’s ability to reign in the deficit, despite expected tariff-revenues and its efficiency drive.
Figure 2: Investors may be pricing in higher inflation and term premia4
Market liquidity has taken a hit
We have observed Treasury and corporate bid-ask spreads widening two to three-fold. According to JP Morgan’s market depth indicator, Treasury market liquidity is the thinnest since the regional banking crisis in 2023 and the height of the pandemic5.
On April 11, the CME increased its margin requirements for SOFR (secured overnight financing rate) and Fed funds futures, reflecting higher volatility. However, it has not yet done so for Treasury futures or cleared interest rate swaps.
There have been concerns about hedge funds becoming forced sellers of Treasuries to meet margin calls on their highly levered Treasury futures basis trades, similar to what happened in 2020. We have seen little evidence of it happening yet, its memory is fresh in investors’ minds and may be contributing to sentiment.
Elsewhere, SOFR swap spreads saw sharp moves over the week, particularly at longer tenors (Figure 3). We believe this is driven by forced unwinds of a popular deregulation-based trade (where investors are long Treasuries versus swaps).
Figure 3: Large moves in SOFR swap spreads6
Overall, we have observed funding costs for Treasury futures and Treasury total return swaps rise by ~5-10bp and equity total return swaps have fallen by ~5-10bp.
The environment may suit fixed income – but It’s time to embrace uncertainty
This episode has raised further questions about the US’ status as the ultimate safe haven. However, we see no immediate alternative to the US as the world’s global reserve currency. At some point, we believe there will be a limit to how far long-dated Treasuries sell off. Hypothetical levels in the 5% to 6% range would, we suspect, be attractive to many global investors. The Federal Reserve would also, in our view, stand ready to intervene if needed. In our view, it may be a matter of time before investors warm to duration exposure.
For now, we believe fixed income assets, particularly short-dated high quality sovereign curves, look attractive. Staying close to home, but remaining nimble and employing the optionality of tactical liquidity may best position investors to take advantage of compelling entry points. Some may already be available in credit, with investment grade yields at ~5.5%, high yield over 8.5% and nominal agency MBS spreads at ~70bp7. We also see global fixed income as attractive, given wide diversification and ability to target alpha opportunities among tariff winners and losers.
Investors nonetheless face substantial uncertainty. We believe this elevates the importance of managing risk and hedging liquidity. In our view, the key lies in embracing uncertainty and building resilience by focusing on managing to a desired outcome, eliminating uncompensated risks, focusing on contractual sources of return, and managing cashflow risks.
