(Bloomberg) -- A popular trade is gaining even more steam in the Treasury market as tariffs muddy the Federal Reserve's interest-rate path and concern builds around US growth: Buy five-year notes.
Leading up to President Donald Trump's April 2 deadline on levies, the options market shows a preference by traders to own exposure to US government debt due in five years. That high demand has pushed the extra cost of owning options that'll pay out if those notes rally has risen to the highest since September.
"The five-year sector should benefit the most from a Fed that might be late to start to cut rates due to higher inflation," said Priya Misra, portfolio manager at JPMorgan Asset Management. "The longer the Fed waits, the more they will need to cut more in totality."
Five-year notes have been touted across Wall Street in recent months as an attractive offering among Treasuries, in large part because of their relative resilience to dual risks. By contrast, two-year notes are ultra-sensitive to the Fed's interest-rate policy, while those maturing in 10 and 30 years tend to be more vulnerable to concern about US economic health and ballooning deficits.
Investors have grown increasingly wary about whether — and to what extent — tariffs will ultimately spur inflation that keeps the US central bank on the sidelines, especially as central bank officials cite uncertainty. As a result, policy-sensitive two-year yields have risen from an early-March low to around 4% as the market prices in two rate cuts this year starting in July.
Ten-year yields have also crept higher in recent weeks as deteriorating consumer confidence leaves investors concerned about a pullback in top-tier data, including the March jobs report due on April 4. Meanwhile, options flows in the past week show traders targeting a decline in five-year yields to about 3.55% by April 25.
On Wednesday, a $70 billion auction of five-year notes lured a yield of 4.1%, slightly above where they were trading at the 1 p.m. New York time deadline. That signaled investors demanded a higher return at the sale.
Still, the gap between five- and 30-year yields was the biggest since September as the Congressional Budget Office warned that the federal government could run out of enough money to pay all of its bills on time as soon as August. Yields on most Treasuries were higher by one to three basis points on the day, with stocks diving on concern around tariffs.
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