Fixed-income traders are escalating so-called curve steepener positions that favor short-dated U.S. Treasuries while taking a more bearish view on long-term bonds. In a steepener trade, yields on longer-maturity Treasuries rise relative to those on shorter-dated securities as investors demand more compensation for exposure to extended risks such as inflation and growing U.S. fiscal deficits.
This positioning has endured even as uncertainty persists around the conflict in the Middle East. Market participants say a steepener can be a viable bet whether the situation calms or deteriorates further, highlighting a rising focus on the U.S. fiscal outlook that until recently appeared to be improving.
Developments over the weekend added to market tension. On Sunday, President Donald Trump said the U.S. Navy would begin blockading the Strait of Hormuz after protracted talks with Iran failed to produce an agreement to end the war. That announcement risks disrupting a fragile ceasefire that had been in place for roughly two weeks.
Despite that geopolitical flashpoint, bond traders appear to have largely priced in downside scenarios and are moving beyond immediate headline risk. The MOVE index - a gauge of rate volatility - fell to a five-week low of 72.15 after topping out near 115.02 at the end of March. Options tied to interest rates also point to reduced expected volatility, with analysts noting short volatility positioning across the curve. These signals suggest participants expect less turbulence in interest rate swaps, instruments used to hedge exposure to changing rates and Treasury securities.
Padhraic Garvey, head of global rates and debt strategy at ING in New York, summed up the view by saying markets are navigating a rocky patch but do not center on a return to full-scale war. He noted that inflation expectations are pressuring the back end of the curve while expectations of no further Fed hikes keep the front end anchored - a setup that supports a curve steepener.
Market strategy reflects an assessment that the Iran conflict is unlikely to trigger a persistent inflation surge that would force the Federal Reserve to raise policy rates. Instead, the immediate economic impact is seen as tilted toward slower growth - driven by weaker demand as higher oil prices weigh on activity - which could in turn reveal strains in the labor market and push policy toward eventual rate cuts. Under that scenario, front-end rates remain subdued by easing expectations or a belief that the Fed will not hike further, while longer-term yields climb amid ongoing price pressures and the prospect of increased Treasury issuance to finance elevated deficits.
Vishal Khanduja, head of the broad markets fixed income team at Morgan Stanley Investment Management in Boston, said that as yield curves normalize, the probability of rate cuts will rise. He expects one or two rate reductions later in the year after the war, a view he ties to what he describes as underlying weakness in the labor market that should become more evident over coming quarters.
Nevertheless, near-term rate cuts have been largely priced out. On Monday, U.S. rate futures incorporated around 6 basis points of easing for 2026, according to LSEG estimates, down sharply from about 55 basis points priced in before the outbreak of hostilities in late February. By late July of next year, futures imply roughly 15 basis points of rate declines. This repricing has sharpened investor focus on inflation risks farther out the curve, leaving longer-dated Treasuries more exposed.
Fuel prices are expected to stay elevated for months even after any reopening of the Hormuz Strait. The U.S. Energy Information Administration projected that Brent crude will average $96 a barrel this year, a factor that supports upside pressure on inflation. Beyond direct price effects, the long end faces potential strain from heavier government borrowing and broader fiscal pressures tied to the conflict. The Pentagon is seeking more than $200 billion in supplemental funding from Congress for the Iran war, in addition to the roughly $900 billion defense appropriation already enacted for fiscal year 2026.
Against that backdrop, Khanduja identifies the 5/30 U.S. Treasury yield differential as having the most room to steepen. On Monday, the spread between five-year and 30-year yields stood at 96.9 basis points. That spread had been 114 basis points before the war and narrowed to 82 basis points at the height of the conflict.
Other strategists express similar thinking and argue the steepening trade remains compelling even in more adverse scenarios. Guneet Dhingra, head of U.S. rates strategy at BNP Paribas, said that if the Middle East conflict escalates further, attention will turn to how the additional costs are funded. He highlighted that funding needs are not merely one-time but could reflect a persistent increase in the U.S. defense budget. In an escalation scenario where growth worries temper inflation fears, front-end yields could stay subdued while the long end moves higher as deficit concerns mount.
Implications for markets and sectors
- U.S. Treasury market - positioning is skewed toward short-end stability and long-end vulnerability, with the 5/30 spread identified as a focal point for steepening.
- Energy sector - elevated oil prices tied to Strait of Hormuz developments are contributing to medium-term inflationary pressure.
- Defense and fiscal sectors - additional borrowing to finance military operations and already-large defense appropriations increase issuance risk and fiscal pressure.
- Labor market - expectations of weakening demand and potential cracks in employment underpin forecasts for eventual Fed rate cuts.
This positioning reflects a market that has moved past immediate panic and is trading based on an assessment of longer-term inflation and fiscal dynamics. The steepener trade captures a view that policy easing will come eventually while inflation and fiscal weight push long-term yields higher - a combination that leaves the yield curve poised to steepen further unless the geopolitical situation or economic data shifts that balancing act.