U.S. Treasury Market Surges as Government Shutdown Looms; Bond Yields Slide on Fed Rate Cut Speculations

Treasury Rally Fueled by Shutdown Fears and Rate Cut Expectations

As the possibility of a federal government shutdown intensifies, the U.S. Treasury market is experiencing a robust rally, driven by increasing bets on future Federal Reserve rate cuts. Bloomberg reported on September 30 that options traders have placed significant wagers on the benchmark 10-year Treasury yield dropping to 3.95%, marking its lowest level in five months.

Declining 10-Year Treasury Yields Amid Economic Data Void Concerns

On September 30, the yield on 10-year U.S. Treasury notes closed at 4.154%, reflecting a modest decline of 1.3 basis points from the prior day. This drop extends downward pressure that began late last week as investor anxiety over a potential government shutdown grows. Lower yields signal rising bond prices, a common market response to heightened uncertainty.

Major concerns stem from the possibility of key economic reports being delayed during a shutdown. The Bureau of Labor Statistics has confirmed that critical releases, including the employment report, would be suspended if the shutdown occurs. Without these reports, the Federal Reserve would face the challenge of making policy decisions at its October 28–29 meeting using outdated or incomplete information.

Ian Lyngen, a strategist at BMO Capital Markets, noted the market’s reaction: “Investors are correlating the likelihood of a government shutdown with the Fed adopting additional easing measures, which seems like a rational outlook given the circumstances.”

Options Market Activity Signals Further Yield Declines

In the bond options market, traders are taking aggressive positions on falling yields. These bets align with expectations that the 10-year Treasury yield could plummet to a range of 4.05% to 3.95%. A notable example involves an options contract worth approximately $35 million that was initiated on September 29, targeting yields below 4.05% before the November 21 expiration date. Additionally, last week saw nearly $50 million in options positions aimed at driving yields to 3.95%.

Historical trends bolster these expectations. Citigroup highlighted in a recent memo that past government shutdowns have proven to be beneficial for Treasury prices. “During the extended 2018 shutdown, the 10-year Treasury yield dropped by around 50 basis points,” the bank observed.

Bullish Sentiment Grows in Cash Treasury Market

The cash market for U.S. Treasuries reflects a surge in bullish sentiment. According to a JPMorgan investor survey, long (buy) positions in Treasuries reached their highest levels since April last week, while short (sell) positions saw a 2-percentage-point decline. This shift indicates rising confidence among investors that the Fed might pivot to rate cuts, particularly if economic uncertainty increases due to the absence of critical data during a prolonged shutdown.

The lack of real-time economic indicators creates a complex backdrop for monetary policymakers. Extended uncertainty is nudging market participants to position themselves for a scenario in which the Federal Reserve could opt for a precautionary rate reduction.

SOFR Options Market Gains Momentum on Rate Cut Speculations

Activity is also ramping up in the short-term interest rate futures market, specifically in Secured Overnight Financing Rate (SOFR) options. The most actively traded contract is the December 2025 96.625 strike call option, suggesting heightened expectations of lower rates in the coming years. Additionally, traders are deploying complex strategies like 96.50/96.625 call spreads and 96.375/96.50/96.625 call flies, further signaling expectations of a 50-basis-point rate cut by year-end.

These trends underscore growing confidence that the Fed may soon implement more dovish policies to counteract economic headwinds and market volatility sparked by the potential shutdown.

Expert Insights: Shutdown-Driven Data Delays Could Spur Policy Easing

Market strategists caution that future Treasury yields will remain highly dependent on key economic data releases, particularly the September employment report and the mid-October Consumer Price Index (CPI). However, a prolonged shutdown would delay these updates, depriving the Federal Reserve of crucial insights and potentially forcing it to act preemptively to mitigate uncertainty.

Jay Woods, strategist at Freedom Capital Markets, emphasized this possibility: “If employment data comes in weaker than expected or its release is delayed, the market is almost certain to interpret it as a catalyst for immediate rate cuts from the Fed.”

Conclusion: A High-Stakes Environment for U.S. Treasury Markets

The U.S. Treasury market is entering a pivotal phase as shutdown concerns and data uncertainties steer investor strategies. With yields declining and bullish sentiment rising, both the options and cash markets reflect a strong belief in potential Federal Reserve rate cuts. However, much hinges on whether key economic reports will be available—or delayed—during the crucial weeks ahead. As the standoff in Washington unfolds, all eyes remain locked on its ripple effects across the bond markets and the Federal Reserve's policy decisions.