Resurgent inflation pressures have driven global bond yields to multi-year highs. The yield on the 30-year U.S. Treasury note reached 5.18%, its highest level since 2007; the 10-year yield also climbed to 4.66%, a new high since January 2025.
The market had anticipated that a shift to more accommodative monetary policy under incoming Federal Reserve Chair Walsh would push U.S. Treasury yields lower. However, a new report from Guotai Haitong Securities indicates this expectation severely overestimates the Fed's operational latitude.
The report argues the U.S. currently faces three major structural domestic constraints: persistent inflation, expanding fiscal deficits, and an AI capital bubble, collectively leaving the Fed with far less room to maneuver than markets assume. Concurrently, three external pressures—global supply chain restructuring, spillover effects from monetary easing by major trading partners, and the ongoing decline in the dollar's global reserve status—are further eroding the external conditions necessary for a decline in U.S. Treasury yields.
Against this backdrop, regardless of who leads the Fed, the potential for a significant decline in long-term yields is extremely limited, making a yield curve steepening the most probable path forward.
**Domestic Constraints: The Triple Bind of Inflation, Fiscal Policy, and the AI Bubble**
Three structural domestic constraints have significantly narrowed the Fed's policy space.
Inflation persistence is intensifying. In April 2026, the U.S. headline CPI rose 3.8% year-over-year, while the core CPI increased 0.4% month-over-month, marking the largest monthly gain of the year. The Atlanta Fed's sticky price CPI rose at an annualized rate of 4.6%, with the core measure jumping to 4.8%, indicating inflation pressure has deeply embedded itself in slower-moving components like rent and services. Mainstream forecasts suggest the May year-over-year CPI could exceed 4%, making re-accelerating inflation the baseline scenario. In this context, a premature rate cut would struggle to gain political support within the FOMC and would challenge the Fed's credibility.
Expanding fiscal deficits are exacerbating pressure on the long end. The federal deficit for fiscal year 2025 reached $1.8 trillion, and large-scale tax reforms and spending plans over the next decade are projected to add over $3 trillion to the deficit. The Treasury Department has significantly increased bond issuance, with short-term T-bill supply potentially surging by over $1 trillion in the second half of the year. Subsequently, pressure from the supply of longer-dated coupon bonds will transmit to long-end yields. With supply persistently high and demand lacking marginal increases, long-term rates face structurally upward pressure. Even if the Fed cuts rates, the 10-year Treasury yield may not necessarily follow suit downward, as monetary policy transmission is significantly weakened in the face of fiscal pressure.
The AI bubble is fueling inflation and market risks. In 2025, the four largest tech giants' AI-related capital expenditures reached approximately $410 billion, accounting for about 1.3% of U.S. GDP, a figure projected to rise to 1.6% in 2026. Massive capital spending driven by the AI narrative is pushing up prices for energy, land, and advanced manufacturing. The S&P 500 is valued at about 23 times forward earnings, a bubble level nearing that of the early-2000s dot-com era. This sustained surge in real investment continues to fuel inflation. Should the bubble burst, the Fed would be caught in a dilemma between stabilizing markets and suppressing inflation. Merely changing the Fed Chair is unlikely to achieve an overall downward shift in the interest rate curve.
**External Erosion: Waning U.S. Pricing Power Amid Global Supply Chain Restructuring**
Global structural forces are also undermining the foundation for lower long-term U.S. rates from three dimensions.
Tariffs are reshaping supply chains and raising the inflation baseline. Excluding low-cost sources from global supply chains forcibly elevates the global cost base for production. Data from the St. Louis Fed shows that between June and August 2025, tariffs contributed about 0.5 percentage points to the annualized U.S. PCE inflation rate. On a 12-month basis through August 2025, tariffs accounted for 10.9% of overall PCE inflation. The transmission mechanism of "tariffs as inflation" has been robustly validated by data.
Currency fluctuations amplify re-inflation risks. Major manufacturing nations are responding to trade frictions with monetary easing, and their weakening currencies export exchange rate volatility and commodity price pressures globally. Alternative supplier nations have longer and more costly capacity-building cycles, amplifying global goods re-inflation risks in the short term. The International Monetary Fund notes that tariffs act as a supply shock for the U.S. but a demand shock for other economies, further diverging inflation patterns and significantly increasing the difficulty of global central bank policy coordination.
The dollar's reserve status is weakening, dampening external demand for U.S. Treasuries. The dollar's share of global official foreign exchange reserves has fallen from about 71% in the early 2000s to about 56% currently, hitting a near two-decade low. Central banks are accelerating diversification, steadily increasing the strategic allocation to gold, the euro, and emerging market currencies. With marginal buying from foreign central banks weakening, the demand support for long-term U.S. Treasuries is becoming increasingly thin. The Fed's own research acknowledges that if confidence in the U.S.'s debt-servicing capability or currency management wavers, demand for dollar-denominated assets would face more profound erosion.
**TACO Unlikely to Alter Rate Trajectory; Curve Steepening the Probable Path**
The so-called "TACO" (Trump Always Chickens Out) pattern describes the recurring phenomenon where markets sell off after Trump announces aggressive tariffs, only to rebound when the White House softens its stance. Following the 2025 delay of tariffs on Europe, the S&P 500 gained over 2% in a single day, but the 30-year Treasury yield concurrently approached 5% again. The bond market's message is clear: tariff concessions do not solve the core variables of fiscal deficits, sticky inflation, and supply pressures, which are central to long-end pricing.
Regardless of the policy path the Fed under Walsh pursues, a curve steepening remains the most likely outcome.
Path One: Continue rate cuts. Short-end rates would fall with the federal funds rate, while the long end, constrained by fiscal supply and inflation premiums, would move more sluggishly, resulting in a bull steepening scenario. Since the Fed began its rate-cutting cycle in September 2024, the 10-year Treasury yield has not fallen but instead risen, climbing from 3.65% to a peak of 4.79% in January 2025.
Path Two: Accelerate easing. If the Fed, under political pressure, speeds up its easing pace, markets would question its independence, leading to a repricing of inflation expectations and a further increase in the term premium for long-term rates. The current 10-year term premium is already at its highest level since 2011.
In summary, a one-sided bet on a significant decline in the 10-year Treasury yield offers a very poor risk-reward ratio within the current macroeconomic framework. In contrast, trades betting on a steepening curve, such as 2s10s or 5s30s, hold a clearer advantage—supported by expectations for short-end rate cuts while also benefiting from long-end supply pressures and inflation premiums, offering a superior risk-reward profile. Trump's TACO pattern may provide tactical windows for long positions, but these represent tactical maneuvers, not a shift in strategic direction.
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