Deutsche Bank Is Betting Against 10-Year Treasury Debt. Why It Could Make Sense.

Bond markets are divided over the likely reaction to Fed rate cuts. (ANGELA WEISS/AFP via Getty Images)

The bond market could be setting itself up for trouble, and market watchers are paying attention. Deutsche Bank could be in position to benefit.

Investors are pricing in more interest-rate cuts than the Federal Reserve may be willing to deliver, in response to continued pressure from President Donald Trump and members of his administration, skeptics about this summer’s rally in bond prices say. Treasury Secretary Scott Bessent was the latest to throw down the gauntlet on Wednesday, calling for steep reductions in borrowing costs based on softening data in the labor market and what he sees indications that inflation will remain steady.

Bessent told Bloomberg Television that his own rate model suggests “we should probably be 150, 175 basis points lower” than the current fed-funds rate, which sits between 4.25% and 4.5%. That would imply at as many as seven quarter-point rate cuts from the Fed, which hasn’t lowered its benchmark rate since December.

His latest rate cut push isn’t surprising: Only a few weeks ago, he accused the Fed of “fear mongering over tariffs” and argued for a review of “the entire institution.” But it does highlight the conflict in the bond market. In a statement issued just last month, following the Fed’s July meeting, policymakers said “we see our current policy stance as appropriate to guard against inflation risks.”

Investors are increasingly anticipating rate cuts. Yields on the benchmark 10-year Treasury note, perhaps the market’s most important interest rate given its ties to both personal lending and global asset prices, have fallen 30 basis points, or hundredths of a percentage point, from their peak in late May.

The paper was marked at 4.235% in midday Wednesday trading, around 56 basis points higher than the yield on benchmark two-year Treasury notes. The rally in 10-year notes has helped boost stock prices to a series of record highs, reduced government borrowing costs, and lowered mortgage rates.

Deutsche Bank analysts, led by Matthew Raskin, think the 10-year price rally, which moves yields lower, has gone too far. The bank is starting to bet against it. “One rationale for the trade is that the terminal Fed policy rate priced in markets is too low,” Raskin and his team wrote in a report published Wednesday.

A terminal rate is meant to peg a level where markets feel the central bank will conclude a rate-cutting cycle. It differs from a so-called neutral rate, which is a theoretical level where the Fed feels comfortable that it isn’t stoking inflation or stifling growth.

Citing futures pricing linked to the Secured Overnight Financing Rate, a global market benchmark for U.S. dollar funding administered by the New York Fed, Raskin said investors are pricing in a terminal Fed rate of 3%.

A terminal rate of 3% implies around 125 basis points in cuts from the current fed-funds rate. Raskin sees that “as “significantly below our preferred measures of nominal neutral, indicating expectations for more [Fed] easing than we see as justified by the inflation and labor market outlook.” .

Whether rates should be cut, and by how much, is a crucial market debate. Employment growth has been slowing, but the headline unemployment rate remains near historic lows at just 4.2%.

Core inflation is ticking higher, as evidenced by Tuesday’s July consumer price index report, but the fact that the headline inflation rate rose less than expected triggered a stock market rally. Short-term Treasury yields fell.

As a result, Jonas Goltermann, deputy chief markets economist at Capital Economics, thinks bond markets could be ripe for a repricing.

First, he argues that Trump’s effort to reshape the Fed, and his decision to fire the head of the Bureau of Labor Statistics, are “problematic for the outlook for long-term Treasuries.”

A cautious Fed could make things worse. Last year, Goltermann noted, 10-year note yields surged by around 90 basis points between September and December even as the Fed began cutting interest rates. Why? Because the reductions didn’t meet market forecasts.

“Long-end yields could rise even were the Fed to resume cutting rates later this year if those cuts prove more shallow than the 125 basis points of cumulative cuts that are now discounted in the money market,” he said.

Write to Martin Baccardax at martin.baccardax@barrons.com