As U.S. Treasury yields "soar," the correct approach may be to increase holdings in U.S. Treasury bond ETFs

According to Zhitong Finance APP, last week, global headlines mainly focused on the continued strong economic data from the United States, prompting the market to reassess the prospects for Federal Reserve interest rate cuts. Wall Street investment institutions, including Bank of America, even began pricing in a scenario where the Federal Reserve would not cut rates throughout 2025. This hawkish market expectation, combined with the increasingly large interest on U.S. Treasury bonds, and the new government led by Trump focusing on "domestic tax cuts + external tariffs" for economic growth and protectionism, may force the U.S. Treasury's bond issuance scale to expand even more than the Biden administration's excessive spending during the "Trump 2.0 era," leading to a significant sell-off in the bond market.

Even major news or important technological advancements in the AI field, such as those from AI chip leaders NVIDIA (NVDA.US) and AMD (AMD.US), found themselves pushed to a secondary position, as the strong labor market and inflation expectation indicators—data that the Federal Reserve, which is in a process of easing policy, does not want to see—became the market focus.

Last Friday, the 10-year U.S. Treasury yield, known as the "anchor of global asset pricing," surged to 4.79%, the highest level since October 2023. The yields on 20-year and 30-year U.S. Treasuries also reached multi-year highs, primarily due to the latest non-farm payroll report and a series of labor market data that exceeded expectations, leading investors to price in a resurgence of inflation and the possibility that the Federal Reserve may not cut rates in 2025. Coupled with the policy expectations of "King of Understanding" Trump, this prompted widespread bond selling, further supporting the argument for the Federal Reserve to pause interest rate cuts.

Recent strong economic data and some hawkish remarks from Federal Reserve officials have significantly changed the outlook for interest rate cuts. U.S. Treasury traders now expect the first rate cut this year to occur in September, with some traders even pricing in that the Federal Reserve will not cut rates throughout 2025.

Another core reason for the rise in U.S. Treasury yields, especially for long-term bonds with maturities of 10 years or more, stems from the market's high uncertainty and concerns regarding the policies of the newly elected President Donald Trump. The tariff policies and domestic tax cuts promised by Trump could trigger a resurgence of inflation, and these policies may further increase the already high budget deficit of the U.S. Treasury.

After the Federal Reserve shifted to a hawkish stance, the "higher for longer" narrative returned to the forefront, prompting the market to begin pricing in the possibility of no rate cuts in 2025 and a continued upward trend in neutral interest rate expectations. More importantly, the logic suggests that the Trump 2.0 era may accelerate inflation and lead to a rapid increase in the scale of Treasury bond issuance and the federal budget deficit. Additionally, under "de-globalization," major holders of U.S. Treasuries, such as China and Japan, may refuse to expand their holdings and could significantly reduce their U.S. Treasury positions. Investors in U.S. Treasuries are increasingly concerned that the Treasury, which has been issuing bonds in large quantities in recent years, may struggle to repay the increasingly high interest on its debt, thus pricing in higher long-term Treasury yields.

Last Friday, the 10-year U.S. Treasury yield, serving as a benchmark for borrowing and a global risk-free rate, rose by 10 basis points to 4.79%, approaching the highest level since the end of October 2023. A client survey by BMO Capital Markets showed that 69% of respondents expect the 10-year U.S. Treasury yield to test 5% at some point this yearThe yield on the 30-year U.S. Treasury bond broke the important 5.00% mark last Friday, while the yield on the shorter-term 2-year U.S. Treasury bond rose by about 7 basis points.

The benchmark U.S. stock index—the S&P 500 index (SP500) fell 1.94% in the shortened week due to the holiday, closing at 5827.04 points, with two out of four trading days experiencing declines. The technology sector of the S&P 500 index dropped a cumulative 3.10% last week, with the "seven tech giants," including Nvidia, Apple, and Tesla, collectively falling by 1.7%. Nvidia alone dropped about 5.9% over the week.

Concerns about sovereign fiscal discipline are not limited to the United States; France's benchmark borrowing costs have now surpassed those of Greece, and the UK's benchmark government bond yield has also been pushed to its highest level since 2008. The market is increasingly worried about a "Truss moment" in the UK government bond market, which could trigger turmoil in global financial markets.

Is U.S. Treasury still a safe haven?

Investors are demanding higher "term premiums" to cope with uncertainties such as long-term debt, deficits, and inflation, which is the key logic behind the recent significant rise in the yields of 10-year and longer-term U.S. Treasuries. As concerns about the sustainability of the U.S. government's massive debt and long-term inflation risks have intensified, the dreaded "term premium" that sends shivers through financial markets is making a comeback. The so-called term premium refers to the additional yield compensation that investors require for holding long-term bonds.

However, according to an analysis in The Wall Street Journal, in the midst of a turbulent geopolitical situation and a global financial market facing high uncertainty, U.S. Treasuries may prove to be the safest investment choice, especially with yields reaching 4.7% or even 5%, which could attract a rush of global "buying on dips." The rebound of short-term U.S. Treasuries with maturities of 2 years or less may be the strongest under the impetus of buying on dips.

The Wall Street Journal noted that the current situation is unprecedented, as the Federal Reserve can raise benchmark interest rates without harming the fundamentals of the U.S. economy—what is referred to as a "soft landing" for the U.S. economy—while slowly lowering rates during a period of stable labor markets and rising inflation, all while sending hawkish signals.

The report attributed last Friday's negative reaction in the stock market to overvaluation. After years of a surge led by large tech stocks, the one-year expected return of the S&P 500 index has unexpectedly dropped to 4.6%, comparable to the yield on five-year U.S. Treasuries, thereby enhancing the competitiveness of U.S. Treasuries as a sovereign credit asset against stocks as a risk asset.

The report further stated that the currently high yields are expected to attract capital inflows, potentially triggering a wave of oversold rebounds. Additionally, the report indicated that if U.S. economic growth and corporate earnings indeed face downward threats, the Federal Reserve will decisively take stimulative measures, ultimately benefiting bonds; particularly, the price rebound of short-term U.S. Treasuries with maturities of 2 years or less may initially be stronger than that of long-term bonds.

Below are the sovereign U.S. government bond ETFs with the highest quantitative ratings from Seeking Alpha. If there is a recent influx of buying on dips into the U.S. Treasury market, or if the U.S. economy faces a weakening trend leading to a significant rebound in U.S. Treasuries, these ETFs are expected to see substantial increases in value. The specific codes for the U.S. Treasury ETFs are in parentheses, and the Quant Rating represents the specific quantitative rating score.**

Bondbloxx Bloomberg One Year Target Duration US Treasury ETF (XONE) - Quant Rating: 3.13

US Treasury 12 Month Bill ETF (OBIL) - Quant Rating: 3.13

Bondbloxx Bloomberg Two Year Target Duration US Treasury ETF (XTWO) - Quant Rating: 2.98

JP Morgan Betabuilders U.S. Treasury Bond 1-3 Year ETF (BBSB) - Quant Rating: 2.97

Vanguard Short-Term Treasury Index Fund ETF Shares (VGSH) - Quant Rating: 2.96

SPDR® Portfolio Short Term Treasury ETF (SPTS) - Quant Rating: 2.95

US Treasury 2 Year Note ETF (UTWO) - Quant Rating: 2.93

iShares 1-3 Year Treasury Bond ETF (SHY) - Quant Rating: 2.90

Schwab Short-Term U.S. Treasury ETF™ (SCHO) - Quant Rating: 2.90

Franklin Short Duration U.S. Government ETF (FTSD) - Quant Rating: 2.87

Bondbloxx Bloomberg Three Year Target Duration US Treasury ETF (XTRE) - Quant Rating: 2.87

SoFi Enhanced Yield ETF (THTA) - Quant Rating: 2.75

US Treasury 3 Year Note ETF (UTRE) - Quant Rating: 2.74

First Trust Low Duration Opportunities ETF (LMBS) - Quant Rating: 2.70iShares Agency Bond ETF (AGZ) - Quant Rating: 2.61