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The prospect of multiple rate cuts has driven a sharp rally in US Treasuries, but the case for increasing duration in fixed income is not compelling.

Key takeaways

• The steepening of government bond curves reflects building ‘term premium’ as investors demand compensation for uncertainty around inflation and monetary policy.
• We believe tariffs, immigration curbs, and increasing tension between the Fed’s dual policy objectives are the major factors driving long-end US Treasury yields higher.
• We see higher long-end yields as a non-trivial risk to the growth outlook, and with spreads well below medium-term averages, we retain our preference for shorter, higher-quality credit.

US Treasury (UST) yields have been volatile in 2025 as markets continually reassess concerns surrounding tariffs, inflation and growth. Amid the price swings, the more durable trend in fixed income this year has been the steady re-inflation of ‘term premium’ – the extra compensation investors demand for holding longer-term bonds rather than continually re-investing at shorter maturities.

While 10-year UST yields have bounced around this year – a high of 4.8% in January, a low of around 4% in April and multiple sharp direction changes inside that range – there has been an unambiguous rise in the difference between 10-year and 30-year yields (see Exhibit 1).

Three macro factors driving long-end yields higher

In our view, the rise in term premium is not solely due to heavy UST issuance or quantitative tightening. Rather, we believe it is being rebuilt by three macro forces that are widening the range of projections for inflation and rates:

1. Tariffs
   The market’s fixation on tariffs rightly flags a growth headwind, but the second-order effect is a broader range of outcomes for inflation and monetary policy. In the short term, tariffs generate inflation in core goods (how much is uncertain, but it is non-trivial), while weaker growth reduces demand and employment. What matters here is not the exact tariff rate but that the policy function becomes noisier: investors see a wider set of plausible inflation paths and a less certain Fed reaction to whichever path materialises.
   
2. Immigration
   The US disinflation story has leaned heavily on labour supply normalisation. Prime-age participation and immigration helped cool wage growth coming out of the Covid rehiring bonanza without producing a demand collapse. A deliberate curtailment of immigration could potentially reverse this effect. Wages are a slow-moving component of core services; if they stick, so does underlying inflation. The impact on inflation will take time to become known, but it could nudge up the Fed’s estimate of the neutral rate.
   
3. Fed’s growth/inflation conflict
   Where both growth and inflation present risks to the economy, the Fed’s dual mandate goals of stable prices and maximum employment come into conflict. Signalling earlier and more numerous cuts while several inflation components remain not fully subdued puts downward pressure on front-end UST yields and upward pressure on the long end. This is not a judgment on the wisdom of easing; it is an observation that tolerance for inflation appears higher when growth risks loom.

Governments can’t ignore long-end yields

Term premium is rebuilding because investors are facing higher macro uncertainty and a weaker monetary policy anchor, but does this matter?

As governments bias issuance to less costly, shorter-dated bonds, and structural demand for long-dated bonds from insurers and pension schemes falls away, this part of the curve arguably becomes less relevant. However, governments should not entirely pivot to issuing shorter-dated bonds. Termed-out debt provides some immunisation from yield shifts, while issuance focused at the front end brings refinancing risk and rising debt service costs.

In addition, financing costs in a large portion of the rest of the economy depend on long-dated government bond yields, from mortgages to long-dated corporate bonds. A higher premium on this debt will dampen activity, all else equal.

As fixed income investors, we need to actively manage duration and be selective about where on the yield curve we think the best risk-reward is offered. While term premium has risen, for us, the extra compensation is not compelling enough given the ongoing risks to the long end.

With credit spreads well below their medium-term averages, the likelihood is they will gravitate wider in the coming months, and thus our general preference for shorter maturities and higher credit quality remains. At this stage of the cycle, with yields still elevated, we feel we can build a fixed income portfolio at an attractive level of carry without reaching for too much duration or credit risk.

Find out more about Vontobel Strategic Income Fund.

 

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This is a sponsored article from Vontobel.