As the Shutdown Looms, Treasury Yields May Rise in the Third Quarter

US Treasuries were on track to notch a third consecutive quarter of gains Tuesday, with investors gravitating toward bonds as the threat of a federal government shutdown looms over economic growth. The possibility of a slowdown is reinforcing the appeal of safe-haven assets.

‍

Yields declined across the curve, helping Treasuries deliver a quarterly return of about 1.5%, according to Bloomberg’s index. That brings total returns for 2025 so far to more than 5%, putting the asset class on pace for its strongest performance since 2020.

‍

Lawmakers face a midnight deadline to avert a shutdown that could disrupt federal agencies, delay the release of critical economic indicators, and weigh on GDP if it drags on. Historically, periods of extended government closures have sparked rallies in longer-dated Treasury securities, as investors anticipate slower growth and reduced risk appetite.

‍

On Tuesday, the 10-year Treasury yield edged down by one basis point to 4.13%, following a four-basis-point drop in the prior session. Meanwhile, the two-year yield held near 3.60%, hovering close to its lowest levels of the past year.

‍

Scott Buchta, head of fixed-income strategy at Brean Capital, described the recent moves as a “modest flight-to-quality trade.” He noted, “The yield curve is flattening as more investors position for the chance that a prolonged shutdown dampens economic activity.”

‍

Much of the strength in Treasuries this year has been fueled by expectations of additional interest rate cuts from the Federal Reserve. In September, the central bank lowered its benchmark rate to a range of 4% to 4.25%, marking a shift toward easing while still acknowledging that inflation remains above target.

‍

Investors remain highly attentive to labor market trends, which continue to play a central role in shaping Fed policy. Recent data has hinted at softening conditions, adding weight to the case for further cuts. Job openings figures, scheduled for release Tuesday, are expected to provide new insight into hiring momentum, while Friday’s non-farm payrolls report will serve as another key barometer unless the shutdown forces a delay.

‍

Interest-rate swaps tied to Fed meeting dates are signaling roughly an 80% probability of another quarter-point reduction in October, with markets also pricing in an additional cut of similar size in December. These expectations have been instrumental in driving bond prices higher throughout the year.

‍

The standoff in Washington adds another layer of uncertainty for both policymakers and investors. While a short-term closure might have limited economic impact, a prolonged stoppage could weigh on consumer confidence, delay federal spending, and obstruct the release of data the Fed relies on to set policy.

‍

In past episodes, investors have often responded by moving into longer-dated Treasuries, betting that reduced government activity could restrain growth and ultimately push the Fed toward a more accommodative stance. That dynamic appears to be playing out again as bond buyers anticipate potential fallout.

‍

Even with inflation still running above the Fed’s 2% target, the Treasury market has staged a broad rally in 2025. A combination of softer economic indicators, expectations for policy easing, and renewed demand for defensive assets has supported the momentum.

‍

If current trends hold, Treasuries are set to deliver their best annual performance in five years. For investors seeking stability amid fiscal and economic uncertainty, bonds are once again proving to be an essential hedge.

‍