Putting a Steeper Yield Curve to the Test

• The Fed is assumed to be near the end of its easing cycle, with ultra-short and short-term rates expected to remain flat to moderately lower while intermediate to longer-term rates face upward pressure
• Horizon analysis shows 3-month through 5-year maturities producing positive annualized returns, while 10-year to 30-year bonds generate negative returns under a steepening curve scenario
• Treasury Floating Rates, which reference the 3-month T-bill, are positioned as potentially the best-performing ultra-short strategy in this environment

Summary

Key Takeaways:

With the Federal Reserve potentially concluding its rate-cutting cycle, 2026 is expected to see continued steepening of the Treasury yield curve, warranting caution on long-duration bonds. A horizon analysis suggests ultra-short to intermediate-term maturities may deliver positive returns, while longer-dated bonds face underperformance risks as back-end yields rise.

Market Implications:

The analysis focuses on three critical fixed income dynamics: yields at historically normal levels, the ineffectiveness of duration-chasing strategies, and the likelihood of continued yield curve steepening. Author Kevin Flanagan conducted a horizon analysis "shock test" to model interest rate scenarios across the maturity spectrum.

Macro Assumptions:

• Labor market remains stable ("no hire, no fire") with underlying economic strength
• Inflation persists above the Fed's 2% target despite reduced tariff-induced price pressure concerns
• Fed policy bias toward easing but approaching the cycle's end

Yield Curve Projections:

• Ultra-short and short-term rates: flat to moderately lower
• Intermediate to longer-term rates: upward pressure, especially at the back-end
• Overall curve trajectory: continued steepening

Performance Analysis:

The horizon analysis reveals 3-month through 5-year maturities generate positive returns, while 10-year to 30-year bonds produce negative results. Treasury Floating Rates, referenced to 3-month T-bills, emerge as the most compelling opportunity in this environment.

Investment Strategy:

The anticipated scenario argues strongly against extending duration. Ultra-short strategies, particularly Treasury Floating Rates, are positioned to deliver optimal positive returns in a flattening-to-steepening curve environment.

Source: WisdomTree analysis as of December 31, 2025.