June 2025 US Bond Market Outlook

Executive Summary

• Long-term Treasury yield has surged near multi-year high at around 5%. Credit spreads remain relatively tight, economic fundamentals are weakening. The bond market is pricing at a growth narrative that labour market fundamentals do not support, raising the risk of reversal if economic reality underperform expectations. Inflation is modest (headline CPI 2.4% YoY; core 2.8%), and the Fed is in wait-and-see mode. However, labour market cracks are emerging. There is a divergence in the establishment and household survey data with payrolls still growing modestly while the household survey shows significant job losses. Markets are pricing a “Goldilocks” scenario of growth, but bond investors may be complacent.

• Yields at the long end have risen on hopes of sustained growth and. Yet, the labour force slightly weakens. Slowing job creation and corporate layoffs (in part driven by technology) point to a cooling economy. At Cordoba, we expect the Fed to pivot easing by late 2025, supporting long-duration bonds. In the meantime, restrictive policy and geopolitical risks loom large. Our investment stance favour duration and investment grade credit; position for eventual Fed cut but remain mindful of near-term volatility if cuts are delayed. Relative to this uncertain US backdrop, we see a more compelling risk-adjusted opportunity in emerging markets, particularly where disinflation and monetary easing are already underway.

Diverging Surveys Indicates Slight Weakening Labour Growth

• The May household survey showed a sharp drop in participation. The civilian labour force fell by 625,000, and employment declined by 700,000. The decline is large enough to be near the survey’s confidence interval, which entails this might be a real labour force deterioration. Every major age cohort saw job losses. Full-time jobs were hit especially hard, with a plunge in full-time employed persons. Such steep losses in the household survey suggest the market may be weaker than the still-positive establishment data implies.

• In contrast, the establishment survey still showed job gains in May, but only a modest increase of 139,000 jobs. May’s gain was smaller than earlier in the year and below the 150,000 monthly paces needed to absorb the population growth. The labour growth trend is clearly down. Previous months were revised down substantially (March payrolls were revised down 65k). Accounting for these, May’s job increase was effectively only 44k. Such downward revisions often indicate the initial data were overstated, and they point to an even weaker hiring trend.

• The BLS diffusion index (measuring the percentage of industries with employment increasing) underscores the stall in hiring. In May, the diffusion index for total private jobs fell to 50.0 (from 51.8 in April), meaning no net expansion. In manufacturing, the diffusion index slumped to 41.7, indicating a clear majority of manufacturing industries reduced employment.

• Corporate layoff announcements have spiked dramatically in 2025. Through May, U.S. employers announced 696,309 job cuts, an 80% increase versus the first five months of 2024. In fact, the Jan to May total is already close to last year’s full-year total. This wave of layoffs spans beyond just tech. According to Challenger, entry-level hiring is slowing, and companies are citing multiple reasons for cuts – from economic uncertainty to automation. Notably, “Technological Updates (incl. AI)” have been cited as the reason for 20,000+ job cuts so far in 2025.

Benign and Finally on-targeted Inflation

• May’s headline CPI rose just 0.1% MoM from April, and was running at 2.4% YoY, reflecting cooling inflation. April’s CPI report did not show much impact on prices from tariffs as it was in the early stage of Trump’s tariff. The impact of tariffs takes time to influence the producers and retailers pricing decisions. Core CPI (ex-food & energy) is running at 2.8% which is slightly above the 2% Fed target, which has eased considerably and is at its slowest pace in over two years.

• Key inflation drivers have flipped. Supply chains are healed; goods inflation is negligible, which is reflected in the falling used car prices, apparel, etc. Food prices are rising only modestly, around 3% YoY. As of mid-2025, inflation appears to be largely tamed. This gives the Fed room to consider rate cuts if the economy falters.

• The forward rate curve also shows that the market expects today’s yield curve steepness to eventually translate into actual cuts. Forward 2-year yields (18 months out) are well below current 2-year yields, indicating traders see Fed Funds around 3% by late 2025 (versus 4.25–4.50% now). 

• Interest rate futures suggest the Fed will pause through at least mid-2025. No rate cut is priced in for Q2, and less than 25 bps cut is priced by the end of Q3. As of early June, Fed fund futures put only around 60% odds on even a single cut by the September FOMC meeting. By Q4, the market leans toward one of two cuts by year-end (25-50 bps total cuts). The economic data is in a ‘Goldilocks’ scenario where the labour data shows a positive monthly payroll but a negative household change. It suggests that the slowdown is not severe enough to trigger a near-term Fed cut, however, a cut in the year is inevitable. 

Yield Curve Steepening via Long-End 

• After an extended period of inversion, the yield curve has begun to re-steepen. Short-term yields (2-year) have come down slightly in anticipation of future Fed cuts, while long-term yields have risen. As of early June, the 2-year Treasury 4.0% and 30-year near 5.0%, putting the 2s–30s spread back to a positive 100 bps. Even the 10-year is around 4.5%, above the 2-year – a marked change from the deep inversion seen last year. Essentially, the curve is tightening “from the back end,” with long yields doing the work. This steepening reflects several factors: heavy Treasury issuance pushing up long rates, plus the market’s sense that Fed policy is near its peak while inflation uncertainty, term premium pressure the long end.

Easing Credit Market

• Credit spreads have remained relatively stable. The overall IG OAS (option-adjusted spread) is around 130 bps which is slightly wider than early 2024. High-yield OAS hovers near 315 bps which has briefly spiked above 450 bps during the March turmoil before tightening back. These levels suggest that credit markets are not fully pricing in a serious downturn, thus imply a benign default outlook. 

• However, spreads are significantly wider for the weakest tiers. CCC-rated junk bonds carry an OAS near 900 bps up notably in recent years. In contrast, BB/B spreads are much tighter, indicating investors still discriminate by quality. We interpret this as the start of a typical late-cycle pattern: cracks appear first in the riskiest credits (CCC spreads jumping, some distressed cases emerging), while the broader HY index hasn’t yet blown out because higher-quality junk is holding in.

Bottom Line

• We can long forward interest rate contracts to profit if rate cuts come sooner or deeper than priced. For instance, buying futures on the Spring 2026 Fed Funds contract (e.g. ZQH26) or late-2025 contracts (ZQK25) locks in current high implied rates; if the Fed cuts, those contracts will rise in price. Being long such futures is essentially a bet that the Fed will be at a lower rate by those dates than markets presently anticipate. We favour this positioning given our view that the bond market is too complacent about the Fed staying on hold. 

• However, be cautious about the timing risk. If the Fed delays cuts longer than we expect (say into 2026), these positions could see short-term losses. But given the asymmetry (inflation is falling, and the Fed has more room to cut than hike), we see forward longs as a good risk/reward. As always, position sizing and patience are key, since the exact Fed pivot timing is uncertain.

• We believe the high-yield market is under-pricing credit risk. Buying protection on the CDX HY index (e.g., Series 40 or 41) allows synthetically short high-yield credit at current tight spread levels. If economic conditions deteriorate, default forecasts rise, or risk sentiment turns, spreads will likely widen which increases the value of the protection. This trade benefits if market repricing brings spreads in line with deteriorating fundamentals (e.g., HY spreads moving from 315 bps to 450 bps).

• We also expect quality dispersion to intensify in this late cycle. Investment-grade credit remains fundamentally stronger, with shorter-duration IG corporates yielding 5–6% and exhibiting healthier coverage ratios. Meanwhile, HY spreads are not compensating for the rising risk of default, particularly in CCC-rated names. A synthetic quality barbell by longing CDX IG (sell protection) and short CDX HY (buy protection) can capture this divergence. This relative value trades profits if IG spreads stay anchored or tighten, while HY spreads widen. It also partially hedges rates, since IG tends to have longer duration. Be aware that the basis can be temporarily compressed in a low volatility or QE environment, so this strategy is considered more risky.