Understanding the Impact of Rate Cuts on the Treasury Market: Insights from a Leading Analyst

After maintaining interest rates at historically high levels for over a year, the Federal Reserve is anticipated to implement rate reductions during its September meeting. This shift is poised to significantly influence the Treasury market.

The yield on Treasury securities, which represents the interest earned, fluctuates based on prevailing economic and market conditions. Typically, longer-term bonds offer higher yields to compensate investors for locking in their capital until maturity.

An inversion of the yield curve—where short-term yields exceed long-term yields—signals investor expectations of declining long-term interest rates. This inversion has persisted for over two years, but economists predict it will normalize as the Fed’s Open Market Committee (FOMC) initiates rate cuts.

Investopedia engaged with John Canavan, lead analyst at Oxford Economics, to explore how Treasury yields might respond if the Federal Reserve begins lowering rates. The following interview has been refined for clarity and conciseness.

Investopedia: What effects do you foresee from a potential interest rate cut in September on Treasury yields?

John Canavan: The impact largely depends on the magnitude of the rate cut and the Federal Reserve’s guidance regarding subsequent cuts. We anticipate a 25-basis-point reduction in September, with a total of approximately 225 basis points cut throughout the year. Should this materialize as expected, the yield curve will likely undergo a modest correction.

This means front-end yields might currently be undervalued in the short term. As it becomes evident that the Fed may not ease rates as aggressively as markets expect, short-term yields could rise slightly, leading to a flatter yield curve.

Investopedia: For investors focused on fixed-income, what strategies are advisable if the Fed embarks on a rate-cutting cycle?

John Canavan: We project that inflation will remain subdued and the economy robust enough for the Federal Reserve to continue reducing rates throughout the next year. Although short-term yields might experience a slight uptick to adjust to near-term expectations, the broader trend points toward a long-term bull steepening, especially at the front end of the curve.

Throughout 2025, yields are expected to decline as the Fed cuts rates, outpacing any gains at the long end. Consequently, investment opportunities remain promising, particularly in the two- to five-year or two- to seven-year Treasury note segments, which should outperform during this rate-cutting phase.

Investopedia: What should equity investors monitor in Treasury market trends during a rate-cut cycle?

John Canavan: The outlook is favorable for equities. We anticipate steady economic growth at a moderate pace throughout 2025, with no recession on the horizon. Declining rates will reduce borrowing costs for companies and enable refinancing of higher-interest debt, supporting corporate profitability.

Equities have rebounded near recent record highs. While the extent of future record-breaking gains is uncertain, a period of bullish range trading near these highs is plausible. Overall, the environment remains positive, with potential for sustained equity growth over the coming year.

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