US Treasuries: Why Rate Cuts Do Not Guarantee Capital Gains

• Fed policy rate cuts do not automatically translate into gains for long-dated bonds.
• Political uncertainty, debt levels and inflation can push risk premia higher.
• Investors should remain flexible and rely on active duration management.

US Treasuries: Why Rate Cuts Do Not Guarantee Capital Gains

Pressure on the US Federal Reserve to cut policy rates is noticeably increasing. Following weak US labour market data in July, monetary easing is now seen as increasingly likely. Financial markets are currently pricing in up to three rate cuts of 25 basis points each by the end of the year.

Even so, bond investors should exercise caution: the impact of rate cuts on the yield curve — in other words, the distribution of interest rates across different maturities — can vary significantly.

There have been repeated phases in the United States and Europe in which rate cuts at the short end were offset by rising long-term yields. This was the case, for example, last year, when long-end yields rose despite the start of an easing cycle, and in the mid-1970s, when high inflation pushed long-term yields higher despite monetary easing.

In principle, a central bank can actively steer the short end of the curve — meaning bonds with maturities of up to two years — through its monetary policy. The policy rate directly influences the interbank and money markets. Changes therefore usually feed through quickly to short-term government bond yields and credit conditions. By contrast, the development of interest rates at the long end, meaning maturities of ten years or more, is far more complex.

Here, in addition to monetary policy, market participants’ expectations for long-term economic growth, inflation trends and the sustainability of government debt play a major role. Global capital flows, such as purchases and sales by foreign investors, can also have a significant impact. These factors are reflected in the “term premium” — the additional yield premium investors demand for holding bonds with long maturities.
 

Why Long-Dated Yields Can Rise Despite Rate Cuts

Despite policy rate cuts, yields at longer maturities can increase, for example if inflation expectations rise or risk premia move higher. A current example is the German government bond market: since the start of monetary easing in June 2024, the ECB has lowered the deposit rate in several steps from 4 percent to 2 percent.

While yields on one-year Bunds fell from 3.3 percent to 1.9 percent, yields on 30-year bonds rose from 2.7 percent to around 3.2 percent. The triggers included extensive fiscal policy measures — the EUR 500 billion special infrastructure fund and the easing of the debt brake, including exemptions for higher defence spending.

The prospect of additional issuance at the long end increased the term premium and drove yields higher despite expansionary monetary policy.

Bund yield curves before and after the start of the ECB easing cycle
(As of 7 August 2025)
Source: Bundesbank, ECB

A Look at the United States

A similar dynamic can currently be observed in the United States. There, too, the Federal Reserve’s moderate easing in autumn 2024 contributed to a steeper yield curve. However, the political and economic environment in the United States is significantly more complex than in the eurozone. The risk of a policy error by the Fed is correspondingly higher.

Although inflation has recently slowed somewhat, it remained clearly above the central bank’s 2 percent target in July, with headline inflation at 2.7 percent and core inflation at 3.1 percent. The effects of import tariffs are likely to be only partly reflected in the current figures.

The producer price index — an early indicator of inflation that is sensitive to changes in trade costs — rose by 3.3 percent year-on-year in July, significantly more than consumer prices.

Excessive or premature monetary easing could also stimulate the economy through lower financing costs. Given limited production capacity, this would tend to create additional price pressure. Rate cuts in this environment carry the risk that inflation expectations could rise again. As a result, the long end of the yield curve could come under upward pressure, as investors demand a higher yield premium for the additional inflation risk.

This pressure is being reinforced by the expansionary fiscal policy of the US administration. Extensive spending programmes are exacerbating the long-term deficit dynamic. At more than USD 37 trillion, government debt has reached a record level, while annual interest expenses exceed USD 1 trillion — and continue to rise. The resulting higher refinancing needs are also likely to put upward pressure on yields of long-dated government bonds.

In addition, political influence on institutions such as the Federal Reserve and the Bureau of Labor Statistics is increasing. If doubts about the Fed’s independence or the reliability of official data were to grow, investors could demand higher risk premia or reduce their exposure to long-dated US Treasuries.
 

MULTI ASSET AT A GLANCE
 

For Capital Market Iinvestors

Rate cuts are no guarantee of capital gains across all maturities. In an environment in which monetary policy is highly data-dependent and investors react to every new economic signal, the yield curve can shift significantly over short periods.

For the Federal Reserve, the situation is particularly challenging: it must balance price stability against support for the economy, while inflation remains clearly above target and government refinancing needs remain high. If it eases too quickly or too aggressively, the risks of rising inflation expectations — and therefore higher yields at the long end — increase. If it remains too hesitant, a noticeable economic slowdown could follow.

For investors, this means deliberately staggering maturities and limiting duration in order to cushion volatility at the long end, adding inflation-linked bonds as a buffer against rising inflation expectations, and using corporate bonds of solid credit quality to stabilise sources of income.

A flexible approach with regular reviews of the portfolio’s positioning is crucial — especially because new inflation and labour market data are continuously changing expectations for the Fed’s policy path and keeping the term premium in motion.

This article was first published online in Börsen-Zeitung on 20 August 2025.
 

ARTICLE BÖRSEN-ZEITUNG