When we started the year CY25, it looked like UST yields were headed for a large rout compared to G7 peers. Fiscal worries, fed independence, policy flipflops were the buzzword for selling USTs. But mid-way down the year, USTs are now outperforming most of the G7 peers. Both in the 10yr and 30yr space, USTs have outperformed German bonds, UK Gilts, French OATS and JGBs. We believe US fiscal worries are looking less troublesome considering 20-25 BN USD per month tariff revenues. Also Fed might be forced to cut fast to neutral rate level of 3% by March 2026 as employment mandate takes precedence over it’s price stability mandate. Despite concerns over Fed independence and fiscal pressures, US bond markets remain relatively stable, with the US viewed as a safe haven and the "best house in a crumbling neighbourhood". Against the backdrop of turmoil in other debt markets and an overhang of fiscal and economic pressures, the US bond markets might continue to stand out as remarkably stable. We also believe that current US administration stated goal is to bring US rates lower. Hence treasury secretary Bessent might ensure through low duration supply & higher tbill supply that USTs remain well behaved. He has jaw boned on all occasions US yields were rising and he has been till date efficient in this approach. On the other hand, Germany’s stated goal of increasing fiscal to fund defence expenditure is well known and hence the rise in bund yields. Also what is more problematic is the consistent French government stability issues & UK debt worries. In Japan political uncertainty, a reluctant BOJ, sustained high inflation are leading to sustained high JGB yields. Without a move from Japanese lifers bringing back their investments in to JGBs we don’t see a way out of current up trend in JGB yields. For all above reasons we remain bullish on long end USTs against long end G7 peers. Currently the spread between 10yr UST & 10yr bunds is 142 bps. We believe this spread might be ticking down to sub 100 levels sooner than later. Europe fiscal expansion, defence spending, political issues in France etc are multiple headwinds for bund yields. On the other hand, forthcoming rate cuts in US, a favourable duration supply from US treasury and a likely reduction in QT further as bank reserves go down will enable USTs to outperform it’s G7 peers at least till Q1CY26. The risk to our view if US supreme court overturns Trump’s tariffs in which case tariff revenue disappears, US growth turns solid with less scope for rate cuts.

We are fast approaching an environment where we might see significant receiving in US rates across the curve. Not only is the macro environment suitable for US rates after Powell’s dovish commentary yesterday at Jackson Hole, next few weeks will see data points specially +ve for US bond yields trading significantly lower. We start with the month end expected index extension & month end rebalancing (Equities to bonds) for August. The US refunding month of August produces a large +0.12y duration increase (for the US), complimented by a bond/equity rebalance favouring bonds. In US, August is a refunding month, with a typically large duration extension +0.12y, which is above both its August average over the past three years +0.11y, and its 12-month +0.07y. Also on a monthly basis, equities have outperformed bonds in the US, EU, UK and Japan, indicating a month end rebalance from equities towards bonds. Then we have the August NFP (Non-Farm Payroll) coming on 5th Sep which can be sub 50k. In August, continuing claims have remained high at 1950-1972k which are near Sep’21 highs. We believe we are fast approaching a rapidly weakening employment scenario where monthly NFPs can fall below 0 by Oct. (i.e. the Sep reading of NFP might be -ve) Then on 9th Sep we have the upcoming benchmark revision to nonfarm payrolls (NFP), which will likely lead to a large negative revision. This data will be released when the FOMC are in their blackout period. Fed Chair Powell alluded to this data in his JH speech yesterday. We estimate the US economy needs to add ~75K new jobs each month in order for the unemployment rate to hold steady (i.e., the breakeven pace). A number below this signals an uptick in the unemployment rate is likely. Our expectation is for the unemployment rate to continue to move higher, reaching 4.7% by year-end. Fiscally also new tariff revenues are creating large buffers for deficit management. CBO (Congressional Budget Office) in it’s 19th Aug report stated that they estimate that the effective tariff rate for goods imported into the United States has increased by about 18 percentage points when measured against 2024 trade flows. They project that increases in tariffs implemented during the period from January 6, 2025, to August 19 will decrease primary deficits (which exclude net outlays for interest) by $3.3 trillion if the higher tariffs persist for the 2025‒2035 period. By reducing the need for federal borrowing, those tariff collections will also reduce federal outlays for interest by an additional $0.7 trillion. As a result, the changes in tariffs will reduce total deficits by $4.0 trillion altogether. Summary: We see a large 20 bps movement in US rates across the curve by 10th Sep. The short end might see even 30 bps down ward movement if NFP and the upcoming benchmark revision data surprise on the downside. We continue to recommend staying received on 2yr US rates as well as 1yr-1yr US SOFR. By 9th Sep, we are looking for sub 3.5 levels on 2yr UST (CMP 3.7), 3.55 on 5yr UST (CMP 3.76) and 4.10 on 10yr UST (CMP 4.25). On the 1yr-1yr US SOFR position, we are looking for 2.90 levels (CMP 3.08). Markets are pricing in only 54 bps of cuts for REMCY25 which can easily change to 75 bps if our view on Aug NFP and benchmark revision data is correct.

On Monday, 28th July, US Treasury will release its quarterly financing estimates, followed by its full refunding announcement on Wednesday, 30th July. We expect Treasury nominal coupon and FRN auction sizes to remain unchanged for another quarter. We expect about $600-650bn in net bill issuance during Q3 to replenish the TGA to an $850bn steady state by the end of the quarter. Our view is that nominal coupon auction sizes will remain unchanged until August 2026 before growing gradually from there. Such an approach would allow for controlled growth in the bill share and lower the WAM of total debt outstanding towards the long-term average. We think liquidity support buybacks are likely to rise by 50-100%. We don’t think a change in the guidance of “maintaining nominal coupon and FRN auction sizes for at least the next several quarters” is necessary. Hence, Treasury might opt to pair a duration friendly innovation—larger buybacks and potentially a more explicit tolerance of a higher bill share or intent to lower the overall WAM—with language that offers a bit more flexibility.

Last week on 26th June, the Federal Reserve announced proposed changes to the supplementary leverage ratio (SLR) calculations. The changes would primarily impact the global systemically important banks (GSIBs) that are subject to enhanced supplementary leverage ratio (eSLR) requirements. Currently, the requirement is calculated as the sum of a baseline 3% plus a leverage buffer of 2% (the requirement for the insured depository subsidiary is 4%+2%). The proposal would modify the calculation of the buffer to equal 50% of the bank holding company’s Method 1 GSIB surcharge rather than a fixed 2%. Also, in contrast to what was widely expected in the market, there would be no exclusion for Treasuries. However, they have requested market input on whether Treasuries held for trading and Treasuries held at broker-dealer subsidiaries should be excluded from the denominator of the SLR calculations. From a credit perspective, the bullish thesis remains intact, long-term debt needs decline which should help technically and while capital requirements were reduced, SLR was not a binding constraint for most banks so overall CET1 levels should remain stable. Banks have already started to react to this less restrictive outlook for capital, with stock repurchases increasing and CET1 ratios declining from their peak in 4Q24. The optics of providing SLR relief while banks are simultaneously reducing their capital may make it seem like the former is causing the latter. But that is not true, even if they were to happen concurrently. The currently proposed eSLR relief should move the leverage constraint out significantly, to an extent that is unlikely to be binding under most conceivable scenarios. But this will make sense only as long as it is profitable to do so - in other words, adding Treasuries or repo to the asset side needs to be met by liabilities that are cheap enough for this activity to be profitable. The invitation to comment on a potential exclusion for Treasury securities held on the trading books, if approved, would have significant effects. It would mean that market risk would be the main constraint for banks' decision to hold Treasuries, and encourage more hedged positions in Treasuries, such as in swap spreads. Banks could also make more repo available to their leveraged fund clients with the additional balance sheet capacity in the current proposal. We believe that the front-to-belly spreads offer the highest risk-adjusted carry profile. However, if investors lower their threshold for risk there is more widening potential further out the curve. Investors who are buying spreads for a larger increase in risk-bearing capacity, rather than just leverage, should therefore target longer-tenor spreads.

The fate of long end USTs are well tied to long end JGBs. JGB volatility over the last two decades has often preceded volatility shocks in other markets. For example, the surge in 10Y UST yields in June 2003 was preceded by a 100bps increase in 10Y JGB yields. Ten years later, the May 2013 ‘taper tantrum’ set off a VaR shock across both DM and EM bond markets; notably, 10Y JGB yields had increased by c. 70bps in April 2013. 30Y JGB yields have bounced 100bps since 7 April 2025. This has set off a ripple impact on long end USTs too. Globally the fiscal expansion trend does not augur well for long end yields. It has started with JGBs, moved to USTs and will finally end up in Bunds too. The 40 year JGB auction on 28th May might be a litmus test for long end yields. We believe USD-JPY is vulnerable to re-testing downside support at 140. And we see the risk of a substantial re-pricing on a break of 140. This might be the indicator for further sell off in long end UST yields. US treasury secretary Bessent already knows the danger ahead for long end USTs. Last Friday he made comments about how enacting SLR relief was very close. To us it seems like he is jawboning the high level of 30yr USTs. At first it might work but then gradually the market will see through it. There is no way the SLR relief comes into play before Dec’25 and that too will be a choice for US banks. Some US banks who are already heavy investors in USTs might chose not to use SLR relief. Even if some add, they might buy the short end US treasuries rather the duration heavy segment of 10s-30s. Hence we don’t believe this is the end of uptick in long end bond yields globally. In US we believe we might see a structural melt up in long end bond yields as markets realise that inflation is sticky, fiscal deficits are ever worsening, rate cuts are far away & incremental DM debt investor flow is non-US centric. JGBs might suffer the same fate too because of higher inflation, BOJ’s policy inertia and local investor’s lack of demand for long end JGBs. We see 30 yr JGBs crossing 3.5% and 10yr USTs above 4.85%. It won’t happen over night but that is how the global rates might evolve over REMCY25.

This week brings the Q2 Treasury refunding, with the main release on April 30th. We do not expect any change in issuance sizes. We think an adjustment to its guidance of stable nominal auctions “for at least the next several quarters” is unlikely given recent volatility. We believe the Q2 treasury refunding announcements could be mildly +ve for UST-Swap spreads as well as long end yields too. We now expect the 10yr UST to be testing 4.00% levels by end June’25. Stop to the view is a close above 4.45. CMP is 4.24. The combination of the market environment and medium-term uncertainty around funding needs make it hard to have strong conviction on the timing of when coupon auction sizes might rise. We've shifted out our baseline assumption for the start of auction size increases to August 2026 (from February 2026), which would keep the bill share stable modestly above 20% over the medium-term under our current fiscal path. There could also be discussions around increasing the size of buybacks.