Treasuries: The Yield Curve Has Normalized After Two Years of Inversion — What the 60-Basis-Point Spread Signals for Bonds, the Fed, and Your Portfolio

The US Treasury curve as of mid-February 2026 shows a textbook upward slope across maturities. The 2-year note yields 3.47%, the benchmark 10-year sits at 4.08%, and the 30-year long bond pays 4.70%. All three benchmarks have declined meaningfully over the past two weeks: the 10-year fell from 4.29% on February 4, the 2-year from 3.57%, and the 30-year from 4.91%.

The 10-year to 2-year spread — the most widely watched yield curve measure — has narrowed from 74 basis points on February 5 to 60 basis points on February 20. This compression suggests the market is pricing in less aggressive future rate cuts than it was two weeks ago, while long-end yields have also declined on flight-to-quality flows amid trade policy uncertainty.

According to Treasury.gov data as of January 31, 2026, the average interest rate on outstanding Treasury Bills is 3.76%, on Treasury Notes 3.169%, and on Treasury Bonds 3.369%. The total weighted average across all interest-bearing federal debt stands at 3.316% — a figure that has been gradually rising as older, lower-coupon debt matures and is refinanced at higher rates.

The Federal Reserve held its benchmark rate at 4.33% from February through July 2025 — a prolonged pause that tested the patience of markets expecting earlier relief. When cuts finally arrived in the autumn, they came in measured steps: the federal funds rate dropped to 4.22% in September, 4.09% in October, 3.88% in November, 3.72% in December, and 3.64% in January 2026.

That 69 basis points of cumulative easing has had a direct and mechanical effect on the front end of the yield curve. The 2-year Treasury yield, which closely tracks expected Fed policy over its maturity horizon, has dropped in lockstep. But the pace of cuts has been slowing: the December-to-January reduction was just 8 basis points, compared to 21 basis points between October and November.

This deceleration aligns with the inflation picture. The Consumer Price Index reached 326.588 in January 2026, up from 319.679 a year earlier — an annual increase of approximately 2.2%. While that is meaningfully closer to the Fed's 2% target than the peaks of 2022-2023, it remains stubbornly above it. Core services inflation, in particular, has been slow to moderate, giving the Fed limited room for aggressive further easing.

The bond market's current pricing suggests expectations for one or two additional 25-basis-point cuts in 2026, which would bring the terminal rate for this cycle somewhere in the range of 3.15% to 3.40%. That is notably higher than the near-zero rates of the post-2008 era, reflecting a structural shift in the neutral rate assumption.

While the Fed's easing has dominated the monetary policy narrative, the fiscal side of the Treasury market tells a more sobering story. The US government's total interest-bearing debt now carries a weighted average interest rate of 3.316%, according to Treasury Department data as of January 31, 2026. That figure has been climbing steadily as trillions of dollars in debt issued during the zero-rate era mature and are replaced by securities carrying current market rates.

The composition of outstanding debt matters. Treasury Bills — the shortest-maturity instruments — carry an average rate of 3.76%, reflecting current money market conditions. Treasury Notes average 3.169%, and long-term Treasury Bonds average 3.369%. Inflation-Protected Securities (TIPS) carry a real yield of 0.983%, while Floating Rate Notes average 3.744%.

The fiscal burden of these rates is substantial. With total federal debt exceeding $36 trillion, every 10 basis points of increase in the average borrowing cost adds roughly $36 billion in annual interest expense. The Congressional Budget Office has projected that net interest payments will consume an increasing share of federal revenue throughout the remainder of the decade, eventually exceeding defense spending.

For Treasury investors, the fiscal outlook creates a tension. Higher deficits require more bond issuance, which can put upward pressure on yields — particularly at the long end, where term premium reflects supply concerns. At the same time, any fiscal consolidation effort (spending cuts or tax increases) could slow economic growth, potentially pushing yields lower through a different channel. The Supreme Court's recent ruling striking down elements of the tariff framework adds yet another variable, as reduced tariff revenue could widen the deficit further.

US Treasuries continue to serve as the global benchmark for risk-free assets, but their relative attractiveness has been shifting. The 10-year Treasury yield at 4.08% remains well above comparable government bond yields in Europe and Japan, where the European Central Bank and Bank of Japan have been slower to normalize policy from their respective starting points.

Foreign demand for US government debt remains a critical factor. Foreign holders own approximately $8.5 trillion in Treasury securities, with Japan and China as the largest creditors. Recent trends show a gradual reduction in Chinese holdings, partly offset by increased buying from other central banks and sovereign wealth funds. The shift reflects geopolitical hedging as much as economic calculation — diversification away from dollar assets has been a stated goal of several emerging market central banks.

The strong dollar, which has been supported by the yield differential between US and foreign government bonds, creates a feedback loop. Higher US yields attract foreign capital, supporting the dollar, which in turn makes US exports less competitive and imports cheaper — potentially easing inflation but widening the trade deficit. The recent tariff upheaval adds a layer of uncertainty to this dynamic, as trade policy changes can rapidly alter capital flow patterns.

For domestic investors, the global context reinforces one key point: US Treasuries still offer among the highest developed-market government bond yields available. The 4.70% on the 30-year bond, in particular, represents a meaningful real return above current inflation of approximately 2.2% — a luxury that bond investors did not enjoy for most of the 2010s.