To The Moon

With macroeconomic forces in flux—persistent inflation risks, delayed rate cuts, and political uncertainty—Treasury traders are assessing how these dynamics could push yields higher in the short term, leading to further sell-offs in equity markets. This article examines the factors driving yields higher and presents two high-conviction Treasury trading ideas backed by probability assessments.

Rising Yields: What's Driving the Sell-off?

1. Repricing of Fed Rate Cut Expectations

The bond market has been quick to respond to signals that the Fed might keep rates elevated for longer. As the U.S. economy shows resilient growth and inflation remains above the Fed’s 2% target, traders now expect fewer rate cuts in 2024 and 2025 than previously forecast. This shift has exerted upward pressure on Treasury yields, especially at the shorter end of the curve.

• Market Impact: Fewer rate cuts will extend the current higher-for-longer environment, eroding bond prices as yields climb.

• Current Yield Levels: As of October 23, the 2-year Treasury yield trades at 4.07%, while the 10-year yield is at 4.24%.

2. Political Uncertainty Adds Risk Premium

Recent developments in the U.S. presidential election have introduced another layer of volatility. With Trump gaining traction in betting markets, investors are pricing in greater policy uncertainty, particularly around fiscal policy and potential tax changes. A Trump victory could bring a more aggressive stance toward government spending, leading to higher borrowing and further upward pressure on yields.

3. Persistent Inflationary Pressures

Though inflation has eased from its peak in 2022, oil prices remain high, and wage pressures persist. These forces have created sticky inflation in services, compelling the Fed to remain cautious. The bond market is increasingly skeptical of early rate cuts, pricing in the possibility that inflation may reaccelerate.

How High Can Treasury Yields Go?

With inflation proving sticky and rate cuts pushed further out, Treasury yields could rise beyond current levels and may breach the psychological 5% barrier. Higher Treasury yields, in turn, make stocks less attractive by offering more competitive returns with lower risk. This could trigger a market pullback, especially in rate-sensitive sectors such as technology and real estate. With tightening financial conditions, corporate profits could come under pressure, increasing the likelihood of a broader sell-off.

Trading Ideas

1. Trade Idea: Short $iShares 20+ Year Treasury Bond ETF(TLT)$

• Thesis: The TLT ETF (which tracks long-dated Treasuries) tends to decline when Treasury yields rise. With the 10-year yield expected to rise, TLT is likely to fall further as bond prices decline.

• Trade Setup:

  Enter Short Position: TLT around $85 Target Price: $80 Stop Loss: $88

• Rationale: With long-term yields climbing and limited prospects for near-term rate cuts, the TLT ETF is positioned for more downside. Shorting TLT provides a way to profit from rising yields without exposure to futures markets. The trade benefits if inflation remains sticky and the Fed sticks to its higher-for-longer narrative.

• Alternative Hedge: Use Puts on TLT with December expiry to limit risk exposure.

2. Trade Idea: Long $Financial Select Sector SPDR Fund(XLF)$

• Thesis: Banks and financial institutions benefit from a steepening yield curve, as they borrow short-term and lend long-term. With the 2-year yield steady and the 10-year yield rising, we expect financials to outperform other sectors.

• Trade Setup:

  Enter Long Position: XLF at $34 Target Price: $37 Stop Loss: $32

• Rationale: Banks are among the biggest beneficiaries of rising long-term rates, as they increase net interest margins. Additionally, financials are less vulnerable to high-interest-rate environments compared to tech or growth sectors. XLF offers diversified exposure to the sector, including big banks like JPMorgan Chase, Bank of America, and Goldman Sachs.

• Optional Hedge: If the Fed pivots sooner than expected, consider using a stop-loss order or pairing this trade with puts on $Invesco QQQ(QQQ)$ to hedge against market-wide pullbacks.

What Happens Next? Will Rate Cut Expectations Sink the Market?

The bond market faces a delicate balancing act as Fed policy, inflation, and political risks continue to drive volatility. Rising Treasury yields could spark broad market sell-offs, as investors reassess the value of equities in an environment of higher-for-longer rates. Rate-sensitive sectors—such as real estate, utilities, and growth stocks—are particularly vulnerable. If the 10-year Treasury yield breaches 5%, this could act as a psychological trigger for further selling in both bonds and equities.

Conversely, if inflation data surprises to the downside or the Fed pivots toward a dovish stance sooner than expected, Treasury prices could rebound quickly. However, with rate cuts now likely delayed into 2025, we remain cautious about any short-term bullish Treasury sentiment.

Conclusion: Caution Ahead for Bond and Equity Markets

The recent rise in Treasury yields reflects a combination of delayed rate cuts, persistent inflation, and rising political uncertainty. These forces are likely to keep Treasury yields elevated for the foreseeable future, increasing the probability of a market pullback. As traders, the key is to stay nimble and capitalize on the volatility through well-structured trades.

The two trades ideas offer asymmetric opportunities to profit from the current environment. While risks remain, staying disciplined and managing position sizes will be critical to navigating the coming weeks.

We should remain watchful of upcoming economic data and Fed statements for clues on the future path of rates. Until then, expect heightened volatility and further repricing across both bond and equity markets.

Please DYODD.