On August 29, 2025, the U.S. Treasury market witnessed significant changes. According to U.S. Treasury data, the yield on the two-year Treasury note fell to 3.59% at the close of the previous trading day (August 28), its lowest level since September 27, 2024. This decline was even lower than the low reached during the market turmoil in April 2025. This adjustment in the yield curve was not an isolated phenomenon; rather, the entire curve saw a significant dip at the short end (particularly in the two- to five-year range), indicating a market repricing of the future path of interest rates. This development sparked widespread discussion. Mainstream media and economists often focused on Federal Reserve Chairman Jerome Powell's speech at the Jackson Hole conference, arguing that it was the primary factor driving the decline in short-term yields. However, objective analysis shows that this was only a partial explanation. The reshaping of the yield curve largely reflects market expectations of economic fundamentals, including a weakening labor market, subsiding inflationary pressures, and the inevitability of Federal Reserve policy adjustments. More importantly, long-term yields (such as the 10-year) have not surged as expected, but have continued to defy predictions of a "yield explosion." This suggests that the market is not rejecting U.S. Treasuries, but rather expressing its expectation of a low interest rate environment through the curve adjustment. Over the past year, two main arguments have dominated financial and social media, arguing that interest rates should remain high or rise further. The first is inflationary pressure, particularly so-called "tariff inflation." Over the past three years, the Federal Reserve has repeatedly emphasized inflation risks, claiming that the economy is strong and only limited interest rate cuts (such as one) are necessary. However, market data suggests that these concerns lack empirical support. The temporary increase in consumer prices from 2021 to the first half of 2022 is more due to supply shocks (such as the pandemic and geopolitical factors) than to sustained inflation. Data from 2025 shows that core inflation has stabilized near the 2% target, with a cooling labor market further dampening price growth. Take Powell's remarks at the 2025 Jackson Hole conference as an example. He significantly downplayed the threat of tariff inflation and instead acknowledged labor market weakness. This wasn't a sudden shift; it was something the market had long anticipated. The decline in short-term yields reflects the market's consensus that the Fed must cut interest rates, rather than the exorcism of the "ghost" of inflation. Economists often attribute inflation to overly accommodative monetary policy, overlooking the role of recovering global supply chains and weak demand. Objectively speaking, this deviation stems from the Federal Reserve and economists' limited understanding of the sources of inflation. They tend to rely on the outdated Phillips curve model, while the market more accurately captures reality through forward-looking pricing. The second misconception is that an "oversupply of Treasury bonds" is leading to a global "rejection" of U.S. Treasuries. Some view this as political, such as protests against Trump's policies, while others emphasize the sheer size of the debt and the scarcity of buyers. It's true that the U.S. federal debt, exceeding $37 trillion (excluding cross-holdings by federal government departments), does crowd out the private sector and exacerbate economic inequality. However, this does not mean the Treasury market is facing a crisis. On the contrary, the debt burden exacerbates downward economic pressure, which in turn increases demand for safe assets such as U.S. Treasury bonds. Historical data shows that high debt environments are often accompanied by low interest rate cycles as investors seek liquidity and safety. The results of the 2024-2025 Treasury auctions further refute the "rejection" theory. For example, this week's 2-year and 5-year Treasury auctions saw high yields (auction clearance rates) hit their lowest levels since September of last year, indicating strong demand. Although the bid-to-cover ratio declined slightly, this is not a sign of oversupply but rather a natural consequence of declining yields leading to reduced pure investor participation. As yields retreated from their decade-highs in 2023, investors turned to other assets for higher returns, but overall demand remained unchanged. On the contrary, auction prices continued to rise, confirming the market's preference for Treasury bonds. The root of these misconceptions lies in the media's reliance on the perspectives of economists and central bankers, groups often divorced from market realities. Economists' models assume the Federal Reserve controls all interest rates, but in reality, market forces drive pricing through supply and demand dynamics. Social media amplifies minority opinions, creating echo chambers that lead the public to ignore the actions of the majority of market participants. The Yield Curve's Reshaping Mechanism: From Inversion to Bull Market Steepening The yield curve's shift is key to understanding the current dynamics. In 2023, the curve reached a deep inversion (the 2-year to 10-year yield spread reached a record negative level), reflecting market expectations that short-term interest rates will rise due to Fed rate hikes, while long-term interest rates will remain low due to a bleak economic outlook. This is consistent with the curve flattening that began in 2021, as the market anticipated the negative impacts of the pandemic's aftermath and supply shocks. By the end of August 2024, the curve began to uninvert, with the 2-10 year yield spread turning from negative to positive by 1 basis point, and then widening to 25 basis points after the Fed's first 50 basis point rate cut in September. This process is not an anomaly but a typical "bull steepening." In a bull steepening, short-term yields fall faster, causing the curve to steepen at the front end, while long-term yields remain relatively stable or slightly rise. This contrasts with a "bear market steepening" (a sharp rise in long-term yields). Why does a bull market steepening occur? First, the Fed's rate cut signal flips the risk-reward equation. During periods of inversion, investors favor the safety of long-term Treasury bonds; after rate cuts begin, short-term Treasury bonds have greater potential because once the Fed begins cutting rates, it's often difficult to stop. Historically, short-term yields have accelerated their decline after each Fed rate cut, while long-term yields have stabilized due to economic uncertainty. After September 2024, long-term yields briefly rebounded, but this was not a "rejection" of Treasury bonds, but rather a steepening mechanism: the market shifted from long to short, pushing long-term prices relatively low. Secondly, economic fundamentals support this reshaping. Labor market data showed slowing job growth and a rightward shift in the Beveridge curve (the relationship between the unemployment rate and the job vacancy rate), indicating structural weaknesses. The Federal Reserve acknowledged this "transition," with Powell emphasizing that labor risks outweighed inflation risks at Jackson Hole. This is consistent with market expectations: economic weakness compels the Fed to cut interest rates rather than maintain them high. Goldman Sachs strategists point out that the relative value of 5-year Treasury bonds (relative to shorter and longer maturities) is at a historically high level, a situation only seen when the Federal Reserve was near zero interest rates. This is no coincidence, but rather a sign that the market is pricing in a return to the Fed's ultra-low interest rate path. Furthermore, recent movements in swap spreads and forward rates provide further confirmation. Narrowing swap spreads indicate ample liquidity, while falling forward rates suggest expectations of long-term low interest rates. Even Fed officials like John Williams are beginning to acknowledge this reality, suggesting that the interest rate environment in the late 2020s will resemble that of the 2010s. Objectively compare historical cycles: In 2005, Federal Reserve Chairman Alan Greenspan called the lack of long-term yield increases with rate hikes a "puzzle." This stemmed from the flawed assumption that the yield curve tracks the Fed, like a series of one-year forward rates. In reality, markets price independently, taking into account global factors, economic cycles, and investor behavior. The steepening in 2024-2025 is not a new puzzle, but a repetition of a historical pattern. U.S. Treasury Auctions and Market Signals U.S. Treasury auctions provide direct evidence testing the "rejection" theory. Auction data from 2025 shows strong demand. For example, this week's 5-year auction revealed that despite a decline in bid-to-cover ratios, high yields fell to their lowest level since September of last year, indicating a willingness among buyers to accept lower returns. This is not a shift away from a high-yield environment, but rather an increase in demand for safety. Analyzing the bid-to-cover ratio: For both 2-year and 5-year notes, fluctuations in this ratio are negatively correlated with yields. As yields retreat from their 2023 peaks, net investors have declined, but safe haven funds (such as pension funds and foreign central banks) have increased. Since April 2025, despite declining two-year yields, auction bids have increased, reflecting risk aversion and bets on further Fed rate cuts. More broadly, foreign holdings of U.S. Treasuries have remained stable, and global capital inflows have not diminished. While the debt burden remains high, its status as a reserve asset remains unchanged. The media has exaggerated individual auctions as "poor," ignoring the overall trend: rising prices and falling yields. Future Outlook: The Low Interest Rate Path and Policy Implications The reshaping of the yield curve suggests that interest rates will fall further and remain low. The decline in the short-term suggests that the market expects the Federal Reserve to accelerate rate cuts, with the target federal funds rate likely approaching zero. Long-term stability challenges The "explosion" forecast reflects an economic downturn rather than a resurgence of inflation. The Federal Reserve should prioritize market signals over internal models. Economists need to rethink their theories of inflation and interest rates and avoid political bias. Investors may consider opportunities in short-term Treasury bonds but remain vigilant to recession risks.
Overall, this reshaping is not led by the Federal Reserve, but rather a response of the market to reality. Ignoring the mainstream noise and focusing on the data will help us understand future dynamics.
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