A key narrative that has shaped the U.S. fixed income markets over the past week centers on the unfolding divergence between the long and intermediate ends of the Treasury curve. The 30-year yield is inching toward 4.60%, while the 10-year Treasury yield has slipped below the psychologically important 4% level—a move underpinned by improving fiscal optics, tighter swap spreads, and expectations for regulatory relief for major banks.
Fiscal Moderation and Supply Recalibration
The recent softening in yields coincides with a narrower-than-expected U.S. fiscal deficit for 2025, which came in slightly below 2024’s shortfall. In FY 2025 total government spending was $7.01 trillion, and total revenue was $5.23 trillion, resulting in a deficit of $1.78 trillion, a decrease of $41 billion from the previous fiscal year. While the improvement is modest, it has dampened investor anxiety around Treasury supply expansion, helping ease pressure on longer-dated coupon issuance.
As of October, Treasury bills make up roughly 21.2% of total marketable debt outstanding, compared with about 17% a year ago—a shift that channels more financing pressure into the short end of the curve while alleviating supply stress on 10- and 30-year maturities. This structural tilt has coincided with a 10-basis point narrowing in 10-year swap spreads over the past six weeks (to roughly –22 bps from –12 bps), signaling an improved demand backdrop for Treasuries relative to derivatives.
Regulatory Shifts and Liquidity Expectations
A key speculative driver behind the rally is the market’s expectation of potential regulatory adjustments to the Supplementary Leverage Ratio (SLR)—a key constraint on large bank balance sheets. Relaxation of the SLR, last temporarily eased during the pandemic, would enable banks to hold more Treasuries without increasing capital requirements, potentially unlocking $200–$250 billion in incremental balance-sheet capacity for Treasury holdings across the largest U.S. institutions.
Such a move could also alleviate friction in the repo market, where SOFR (Secured Overnight Financing Rate) continues to trade at a slight discount, reflecting soft demand for secured funding rather than a shortage of reserves. Repo volumes have averaged $1.65 trillion per day this month, up from $1.52 trillion in August, but the persistent SOFR discount highlights a system that has ample reserves yet limited intermediation capacity. Liquidity isn’t absent—it’s uneven. An SLR tweak could restore the natural flow of collateral and relieve persistent distortions in short-term funding.
The Inflation Question: Can the 10-Year Hold?
While technical and regulatory factors have created a friendlier environment for duration, inflation remains the wildcard. Headline inflation pressures have shown signs of creeping higher on the back of rising services and energy costs, even as core measures remain sticky around 3%.
This poses a valuation challenge: with the 10-year Treasury yield around 4.02% and the 10-year TIPS (real) yield roughly 1.71%, the implied 10-year breakeven is approximately 2.3%—a level that could be vulnerable if inflation expectations drift higher. Meanwhile, 10-year SOFR swap rates are tracking near 3.55%–3.60% in recent prints (mid-market indications), reinforcing the market’s view that long-run policy rates settle meaningfully below today’s nominal US Treasury yield.
For now, the path of least resistance favors lower yields, with improving deficit optics, front-end-heavy issuance, and potential SLR relief supporting demand for Treasuries. Yet, the long end’s quiet optimism may not survive a renewed inflation impulse. The market’s next test will be whether fundamentals can sustain this rally—or whether price stability concerns will reassert themselves as the dominant driver of rates into year-end.
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