Goldman Sachs has updated its predictions for U.S. Treasury yields. They expect the 2-year yield to end 2025 at 3.45% and the 10-year yield at 4.20%. These new estimates are lower than their previous forecasts of 3.85% for the 2-year yield and 4.50% for the 10-year yield. The changes apply to all key maturities. This shift is mainly due to a higher chance that the Federal Reserve will start cutting interest rates sooner than expected, now likely to happen in September instead of December.

Changes in Monetary Policy Expectations

Goldman’s latest updates show a change in how we view monetary policy. This change comes from weaker economic data and signs that inflation may be stabilizing. Earlier, Goldman expected the Federal Reserve to delay its response, but new data has changed this view. Shorter-term yields usually respond quickly to changes in rate expectations, which is why the 2-year note has seen the biggest drop. The revised forecast for the 10-year yield, while lowered, still reflects ongoing concerns about borrowing and long-term financial issues. We think this lower yield outlook indicates a less aggressive tightening cycle, with rate cuts coming sooner. For those investing in interest-rate products, this adjustment is significant. Powell’s messages and recent comments from the FOMC suggest this cautious direction. Futures markets are beginning to price in a September rate cut, and if the labor market remains weak, this possibility could become clearer. With the expectation of lower returns across maturities, those trading steepening strategies may find them less beneficial if front-end yields continue to rise. This could require a rethink of traditional curve positioning. A flatter curve, which used to signal recession fears, might now result from rate cuts instead of growth concerns, complicating timing for trades. Meanwhile, funding conditions are changing subtly. With short-term yields likely under pressure, costs related to leverage and roll will become more important. For those using swaps or futures, capturing roll benefits may be harder, especially beyond the front end of the curve.

Shifts in Funding Conditions

Yellen’s department continues to issue bonds confidently, supporting long-term yields. However, this new yield trajectory suggests less immediate pressure on the Treasury to change its issuance plans. As a result, supply issues may ease, and TIPS markets could start to adjust to more modest long-term inflation expectations. We’re closely watching rate volatility, especially in the swaption market, which hasn’t fully reflected the Fed Funds futures’ expected changes. Implied rates remain sticky, providing chances for tactical opportunities in volatility compression, specifically around the September expiration. As the Fed communicates more clearly over the summer, liquidity conditions and macroeconomic hedge flows might speed up reshaping of expectations, especially if core inflation trends downward. However, while the overall yield forecast has changed, the skew in yields remains. Traders should monitor any inconsistencies between market expectations and Fed statements during upcoming conferences. Opportunities will arise from both mean reversion and overreactions. Choose your entry points carefully and avoid crowded trades. Create your live VT Markets account and start trading now.

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