As we prepare to look ahead to the U.STreasury bond market in 2025, it’s essential to reflect on the forecasts we made at the beginning of the previous yearThe initial outlook was built on four key predictions, which now provide an insightful backdrop for today's discussion.

The first prediction was the continuation of high volatility in U.STreasury bondsVolatility is often indicative of uncertainty in the financial markets, and indeed, the bond market has experienced significant fluctuations over the past year.

Secondly, we expected a reversal in the yield curve inversion, which was anticipated to stabilize as economic conditions changedIn financial terms, a yield curve inversion occurs when shorter-term interest rates exceed those of longer-term ones, often signaling a recessionOur belief was that this anomaly would correct itself as investor confidence returned.

Our third expectation was that the 10-year U.STreasury yield would dip to around 3%. While we opened the year with a yield of 3.88%, there was an acknowledgment that market expectations could lead to volatility, briefly pushing rates above 4% at times.

Lastly, we predicted that the implied term premium on the 10-year bond, which reflects the additional yield investors require for holding longer-term securities, would return to positive territoryThis metric is crucial as it can indicate investor confidence in the stability of economies over the long term.

However, as we turn our gaze towards the end of 2024, it becomes clear that the reality of the U.STreasury market unfolded differently than expectedAlthough high volatility continued, it was notably less severe compared to 2023's fluctuationsFor instance, over the course of 2024, the 10-year Treasury began the year at 3.88% and ended at 4.57%. The high of 4.74% and the low of 3.6% reflected a total intra-year fluctuation of just 114 basis points, a marked decrease from the previous year's 177 basis points.

As for the yield curve, it indeed reversed its inversion

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The spread between the 10-year and both the 2-year and 3-month Treasury yields turned positive in August and December, respectivelyBy the close of 2024, the yield differences stood at 33 basis points for the 2-year and 21 basis points for the 3-month, effectively ending a 25-month run of inversion between the 10-year and 2-year, and a similar 26-month pattern with the 3-month Treasury yield.

Furthermore, the implied term premium has turned positive as we originally conjecturedIn mid-October 2024, the 10-year Treasury's implied premium shifted from negative to positive, continuing to rise and settling at about 0.5% by year's endThis change marked a significant shift since the premium had primarily remained negative since 2016, reflecting an evolving investor sentiment and market dynamics.

Upon scrutinizing these developments, it becomes apparent that our early assumptions regarding the depth of the potential interest rate cuts post those predicted by the Federal Reserve were overly optimisticInitially, we anticipated a cut of around 150 basis points through 2024, but the actual reductions amounted to merely 100 basis pointsThis discrepancy underscores that the path set forth by the Federal Reserve remains the largest variable affecting market outcomes for 2025.

The Fed's dot plot from its June 2023 meeting indicated a terminal policy rate of 5.6%, which is slightly higher than the actual level once the July rate hike concludedThe Fed initially conveyed a planned reduction to 4.6% in 2024 and 3.4% in 2025. However, ongoing adjustments to this policy have signaled variability in how the market perceives these future cutsPresently, there’s an expectation of a mere 25 basis point cut by the end of 2025, rather than the 50 basis points that had been indicated previously.

Interestingly, the shift in 2-year Treasury yields, along with the changes in implied term premiums, suggest that the market is increasingly pricing in expectations of the Fed not reducing rates in 2025. After reaching a low of 3.6% in 2024, the yield for 2-year bonds has seen a notable increase, now approaching 4.3%. This trend correlates with the current policy levels while the associated term premium has recovered to approximately 0.05%. This recovery signals a market prepared for potential rate hikes, rather than further reductions.

Based on the existing trajectories set forth by the Federal Reserve and current market expectations, it appears increasingly challenging for Treasury yields to drop below 4% in 2025. If inflation risks lead to the Fed tightening the policy environment, we might anticipate further upward shifts in Treasury yields, indicating a more challenging landscape for future bond investments.

Nonetheless, compared to 2024, the potential volatility and risks facing the Treasury market in 2025 are poised to escalate significantly due to two main factors.

First, the U.S. federal government’s debt now exceeds $36 trillion, with interest payments nearing levels comparable to national defense spending

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