Date: 19/06/2003

Analyst: Tommaso T. Bartolozzi

Reviewer: Paolo Gatto

Bond Characteristics:

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How to Trade Long-Term Treasury Bonds Ahead of the Next Fed Rate Cuts

This trade aims to exploit the duration effect of a long-term U.S. Treasury bond (maturing in 2050) to speculate on a potential interest rate cut by the Federal Reserve over the next 12 months. The expectation is that, in a complex yet stable economic environment, the U.S. central bank will not be able to maintain its current restrictive policy for much longer.

Macroeconomic Outlook: What the Fed and the Market Are Telling Us

In the United States, inflation has fluctuated between 3.7% and 2.3% from June 2023 to the present, remaining largely aligned with the Federal Reserve’s informal 3% target. Forward projections through March 2026 suggest inflation should remain within this corridor. Meanwhile, the European Central Bank has already entered an easing cycle, with inflation stabilizing near 2% and multiple rate cuts implemented, easing sovereign debt pressures across the eurozone.

In contrast, the U.S. economy remains resilient: unemployment is historically low, and GDP growth continues at a pace comparable to pre-pandemic levels. While these dynamics may support a dovish policy shift, they also introduce uncertainty about when and how aggressively the Fed might move. In a context of sustained demand, the central bank may prefer to delay easing to avoid reigniting underlying inflationary pressures.

Further complicating the outlook is the reemergence of Donald Trump on the political stage. His platform includes potentially expansionary fiscal policy, increased deficit spending, and renewed protectionist rhetoric. These factors, in theory, pose upside risks to inflation. Tariffs in particular act as indirect taxes on domestic consumers, increasing import prices and filtering through to retail inflation.

However, it’s important to contextualize these risks. A recent 90-day suspension of selected tariffs (which began around April 8–9) has provided temporary relief to global markets and created a meaningful negotiation window for the countries involved. By the time tariffs are reintroduced (currently scheduled for July 9), bilateral agreements or exemptions may already be in place — significantly reducing the expected impact compared to initial forecasts. This dynamic is key: the inflationary effect of tariffs may still exist, but it is expected to be materially softened in both timing and magnitude.

Moreover, both Treasury Secretary Scott Bessent and analysts at Goldman Sachs have suggested that countries negotiating “in good faith” may receive extensions or adjusted deadlines — offering additional time to reach agreements and mitigate risks.

Additionally, any trade-related price pressures must be assessed alongside geopolitical developments, particularly the Israel–Iran situation, which could influence energy prices. Nonetheless, even factoring in these risks, a rate hike by the Fed remains highly improbable. The bar for tightening is extremely high, especially with inflation expectations well-anchored and no signs of overheating in core metrics.

Market Expectations and Rate Cut Scenarios

The greatest risk to a long-duration bond strategy would be a reversal in Fed policy — a surprise rate hike. But given current conditions, this scenario appears remote. For this reason, and to prudently manage macroeconomic and geopolitical uncertainty, the position will be built gradually. This staggered approach allows for tactical flexibility in responding to future developments in monetary policy, trade negotiations, and geopolitical tensions.

From summer 2023 to September 18, 2024, the Federal Reserve held the Federal Funds Rate steady between 5.25% and 5.50%. Between November and December 2024, three cuts totaling 75 basis points brought the rate down to the 4.25%–4.50% range. Since then, the Fed has adopted a wait-and-see posture, closely monitoring both economic indicators and international risks.

Expectations for future monetary policy are primarily priced via Fed Funds Futures traded on CME Group. Tools like the CME FedWatch Tool aggregate this data to reflect market-implied probabilities for each FOMC meeting.

• June 18, 2025: Markets assign a very low probability to further cuts, signaling a temporary pause.

• September 2025: There’s a 55–60% chance of a 25 bps cut, with remaining probabilities split between no change and a more aggressive cut.

• January 2026: Over 90% of participants expect rates to fall within the 3.25%–4.00% range, pointing to a clear consensus for continued easing.

These pricing scenarios reflect a strong belief that the Fed will gradually lower rates over the next 12–18 months — not hike them.

To mitigate residual risk, the position will be built incrementally. This allows for participation in potential dovish surprises (e.g., an unexpected rate cut or a shift in forward guidance), while preserving the ability to adapt rapidly should new data materially alter the policy outlook.

Moreover, the trade will be conducted via a USD-denominated account, eliminating FX risk (e.g., EUR/USD volatility) and allowing a pure focus on U.S. rate trends and the duration effect of long-term Treasury instruments.

Duration, Convexity and Scenario Analysis: How Long-Term Treasuries React to Rate Cuts

The proposed trade aims to leverage the duration effect of a 2050 Treasury bond to capitalize on a potential interest rate cut cycle over the next 12 months. The selected bond features a very high duration, meaning its price is highly sensitive to changes in interest rates.
All else being equal, a rate decrease increases the price of long-term bonds more than short-term bonds, due to the greater exposure of discounted cash flows over time. Additionally, the bond’s positive convexity provides an extra advantage: for symmetric rate movements, the price increase from a rate cut will be greater than the price decrease from a rate hike, resulting in an asymmetric risk-return profile favorable to investors.

The chosen instrument is a 2050 maturity Treasury bond denominated in USD, selected for its high duration and convexity, which are critical to maximizing returns if interest rates decline.
The investment horizon is approximately 12 months, targeting the period where the duration effect is maximized amid a potential Federal Reserve easing cycle. This timeframe balances capturing gains from rate cuts while limiting exposure to macroeconomic shocks or adverse events that may arise over a longer horizon.
Scenario analysis simulating interest rate changes of ±50 basis points (from 4.5% to 4.0% or 5.0%) indicates that a cumulative rate cut of 150 basis points (down to 3.0%) could generate a 34% return on the bond’s value, making this trade particularly attractive in anticipation of monetary easing.

Final Thoughts: A Tactical Bet with Strong Risk-Reward Potential

Given a macroeconomic environment where inflation is under control and growth remains solid, but geopolitical tensions are rising, the Federal Reserve is under pressure to strike a balance between caution and flexibility. The market has already started pricing in a moderate rate cut cycle, and long-term Treasury bonds provide an opportunity to benefit from this scenario thanks to their high duration and positive convexity.

This trade is a well-balanced tactical play: speculative but based on strong macroeconomic fundamentals and pricing dynamics, with prudent currency risk management. Barring any unexpected negative shocks, it offers an attractive risk-reward profile.

Periodic updates will be provided to monitor the progress of the trade and assess any changes in the macroeconomic and geopolitical landscape, ensuring timely adjustments as needed.