Bank of America: Long bonds under pressure after Fed holds rates; BofA still sees Treasury curve flattening

Why did long-term bond yields rise after the Fed paused rate hikes?

During the press conference at the October policy meeting, the US 2-year Treasury yield fell 6 basis points, while the 30-year yield rose 4 basis points. BofA believes doubts about the Fed’s commitment to fighting inflation drove the spread between long- and short-term yields wider.
BofA expects the Fed to raise rates by 25 basis points each in December 2026 and March 2027. The bank believes above-trend growth and above-target inflation will eventually push short-term rates higher and narrow the spread between 2-year and 30-year yields.
But the near-term path is uneven: dovish Fed communications and weak technology earnings have fueled a bond rally, and 2-year and 5-year yields are also approaching levels at which trend-following traders may cover short positions.

BofA believes demand from traditional long-bond buyers has weakened over time, while the US Treasury has increased the share of bonds with maturities over 10 years in its issuance since the mid-2010s. Treasury securities held by traditional sources of long-bond demand account for just 6.5% of outstanding Treasury debt excluding Treasury bills, close to the lowest level since the early 50s of the 20th century.
A further rise in long-term yields would increase the likelihood that the Treasury reduces the size of long-bond auctions; adjustments could appear in the 4 November refunding announcement, but BofA’s base case still does not envisage an immediate reduction on that occasion.

The European Central Bank’s October statement placed greater emphasis on the pressure that financing conditions and energy prices put on growth, but Lagarde repeatedly signaled a leaning toward a rate hike in December. After the meeting, market pricing for hikes over the next year fell by only about 3 basis points, while the hike implied for the December meeting rose from 21 basis points before the statement to 22 basis points.
BofA expects the December hike to be the last of this cycle, with cuts starting in September 2027. The ECB could also hold rates steady in December if economic activity is weaker than expected, financial conditions remain tight and core inflation changes little.
With the central bank still leaning toward a hike and energy prices potentially remaining high, BofA prefers holding duration in the middle of the curve over the shortest end; the spread between French and German 10-year government bonds remains vulnerable to global risk assets.

The UK market has fully priced in a 25-basis-point hike at the next meeting and several more thereafter. BofA believes too much future tightening is priced into forwards and expects the Bank of England to signal limited, gradual further tightening while raising rates to 4.0% at the next meeting; however, persistently stronger-than-expected economic performance, stabilizing employment and higher energy prices would increase the risk of further hikes.
The Bank of Canada raised rates by 25 basis points to 2.50% in October, exceeding BofA’s expectations. BofA expects a pause in December and one more hike in January 2027; if oil prices sustain inflation pressures, hikes could come sooner and be more numerous.
BofA sees the Bank of Canada’s proactive response to inflation as contrasting with the Fed’s decision to hold rates steady this week, and therefore expects Canada’s 5-year versus 30-year spread to narrow further relative to the US spread; an unexpectedly hawkish Fed is a risk to this relative-value trade.

Australia’s third-quarter trimmed-mean inflation rose 1.0% quarter on quarter, exceeding the Reserve Bank of Australia’s August forecast. BofA consequently changed its forecast to a hike to 4.85% in November, but believes the lagged effects of past tightening, a housing market downturn and weakening employment will gradually bring inflation down, potentially marking the peak of this rate cycle.
US repo rates rose at the end of October, which BofA attributes to an increase in the Treasury’s cash account, Treasury bill issuance and Canadian banks shrinking their balance sheets at fiscal year-end. The bank expects Canadian banks’ return, a decline in Treasury cash and the Fed’s resumption of reserve management purchases in mid-November to help funding rates stabilize after month-end.