U.S. Treasury yields continued their decline last week, reflecting mounting worries about the health of the American economy. A series of weak economic reports has reinforced expectations that the Federal Reserve may cut interest rates in 2025, prompting a strong rally in fixed-income ETFs, particularly those with long-duration exposure. Meanwhile, U.S. equities struggled with the S&P 500, wiping out a portion of its year-to-date gains. Additionally, the 10-year Treasury yield has dipped below the 3-month T-bill, marking an inverted yield curve, a historically significant indicator of a potential economic downturn.

Economic Indicators Point to Slowing Growth

The drop in Treasury yields follows a series of disappointing economic data releases, deepening concerns about a slowdown in the U.S. economy. The revised estimate for Q4 2024 GDP growth came in at 2.3%, a significant drop from the 3.1% growth recorded in Q3. Additionally, labor market indicators showed signs of weakness, with weekly jobless claims rising by 22,000 to 242,000 for the week ended February 22, the highest level in over two months. Other indicators signaling economic fragility include:

• Consumer confidence plummeted in February, missing expectations.
• The S&P Global Purchasing Managers’ Index (PMI) fell short of forecasts, raising concerns about slowing business activity.
• Existing home sales dropped in January, underscoring the continued pressure of high mortgage rates on the housing market.

With economic conditions deteriorating, investors now anticipate more aggressive Fed rate cuts in 2025, despite the central bank’s cautious approach.

Recession Signals from the Yield Curve

One of the most notable developments in the bond market has been the inversion of the yield curve, with the 10-year Treasury yield slipping below the 3-month T-bill. Historically, such an inversion has been one of the most reliable indicators of an impending recession, with downturns often following within 12 to 18 months. This trend is fueling speculation that the Fed may need to act sooner than expected to support economic growth.

Fixed-Income ETFs Outperform as Equities Struggle

As bond prices climbed, the S&P 500 gave back some of its year-to-date gains, despite a late-session rebound on Friday. Concerns about Donald Trump’s trade policy are dampening market sentiment. The president announced that tariffs on Canada and Mexico will be implemented once the temporary delay ends, raising fears of economic strain. As trade tensions escalate, investors are shifting towards fixed-income ETFs, favoring safer assets amid increasing uncertainty in equity markets.

At the same time, falling interest rates have provided a boost to long-duration Treasuries and fixed-income ETFs, which are highly sensitive to interest rate movements. This shift in investor sentiment has led to fixed-income ETFs significantly outperforming equities in recent trading sessions.

Potential Dollar Weakness on the Horizon

The transition to a lower interest rate environment could also weaken the dollar. Historically, falling Treasury yields reduce the greenback’s appeal as an investment, since lower rates diminish the appeal of U.S. assets to foreign investors. As a result, a faster rate-cutting cycle by the Fed could put further downward pressure on the dollar.

ETF Performance Reflects the Downturn

Long-term investment-grade government bond ETFs posted solid gains last week, with the segment advancing +3.07% WTD and +4.50% YTD. Investors showed renewed interest, as weekly inflows reached +$25.99 million, bringing total YTD inflows to +$29.40 million.

Among individual ETFs, the Global X U.S. 7-10 Year Treasury Bond Index ETF (HTB) rose +3.44% WTD. Meanwhile, the iShares 20+ Year U.S. Treasury Bond Index ETF (XTLH) gained +3.14% WTD and posted a strong +5.94% YTD performance, attracting year-to-date inflows of +$83 million, reinforcing confidence in longer-duration bonds amid shifting rate expectations.

Here’s a comparison between Fixed Income ETFs

Group Data

Fund Specific Data: ZFL, TCLB, HTB, XTLH, ZTL.F, QTLT, TULB

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.