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Investors have been pulling back from long-term US bond funds as worries over the country’s fiscal situation continue to mount. The Financial Times reported that net outflows from long-dated US bond funds spanning government and corporate debt have hit nearly USD 11bn so far in the second quarter, the fastest pace since the height of the COVID pandemic in early 2020.

While it offers an indication of investor appetite, the data captures only a fraction of the vast US bond market. Treasury yields ha ve also fallen in recent weeks as market sentiment stabilizes.

In fact, we expect Treasury yields to fall further as the Federal Reserve resumes policy easing later this year, while the US central bank’s proposed changes to how much capital large banks must hold against low-risk assets should improve liquidity in the Treasury market.

The Fed remains on track to cut interest rates this year. In his second day of Congressional testimony, Fed Chair Jerome Powell reiterated that the Fed should be careful in considering further interest rate cuts given the risk that US President Donald Trump’s tariffs could cause more persistent inflation. He added that the central bank wants more information about the ultimate level of tariffs and how they impact pricing and public expectations about inflation before lowering borrowing costs any further. But Fed easing this year remains likely, as shown in the central bank’s latest rate projections published this month. Fed Vice Chair Michelle Bowman and Governor Christopher Waller in recent days suggested that they may be open to a rate cut as soon as July. We expect the Fed to resume easing in September, bringing policy rates 100 basis points lower over the next 12 months as economic activity moderates further. Recent data have pointed to slowing business activity, deteriorating consumer confidence, and falling new home sales.

A relaxation in banks’ capital ratios should support liquidity in the Treasury market. The Fed on Wednesday unveiled a long-anticipated proposal that would ease capital requirements for large US banks, allowing them to take on more leverage, especially for low-risk assets like Treasuries. In its draft form, the plan would reduce aggregate capital requirements at the holding company level for eight big banks by 1.4%, or about USD 13bn. A bigger reduction in capital requirements is planned for the deposit-taking subsidiaries of the banks—by 27%, or USD 210bn. Powell described the move as “prudent,” given the increase in safe assets on bank balance sheets over the last decade. Bowman said the proposal “will help to build resilience in US Treasury markets, reducing the likelihood of market dysfunction and the need for the Federal Reserve to intervene in a future stress event.” We think the proposed changes, when in effect, could improve liquidity in the Treasury market.

The US remains able to manage its debt. We expect the Senate to pass the One Big Beautiful Bill Act in the coming weeks, and the legislation is likely to lead to higher US fiscal deficits over the next several years. However, deep US capital markets, the greenback’s reserve currency status, and the significant wealth held by US households should keep the debt manageable, in our view. The Trump administration has also demonstrated sensitivity to higher bond yields, pointing to a willingness to make adjustments in the event of much higher yields.

So, with yields and cash rates expected to fall for the remainder of this year, we believe high grade and investment grade bonds offer an attractive risk return compared to cash, as investors can lock in currently still-elevated yields. Long-term investors can also consider diversified fixed income strategies.