Normalized Treasury Yield Curve Signals Fed May Begin Cutting Rates Soon

The U.S. Treasury yield curve’s recent evolution marks a shift away from the deeply inverted curve that persisted across 2022-24, which many saw as a leading recession signal. As of mid-December 2025, the spread between 10-year and 2-year Treasuries has broadened to around +0.67 percentage point, confirming a return to a “normal” upward slope [2]. This signals investor sentiment that shorter-term rates will start falling, consistent with expectations of monetary easing by the Fed, and that inflation and economic growth may settle at moderate levels [8][7].

However, the shape of the curve is only one indicator—key risks remain. Elevated long-term yields suggest that while short-term rates are expected to decline, markets are wary of persistent inflation or fiscal pressures. Inflation is still above the Fed’s 2% target, putting pressure on real yields and eroding the potential impact of future rate cuts unless inflation consolidates downward [8].

On the policy front, Federal Reserve minutes from December 2025 indicate internal divisions: most policymakers support recent cuts, but several dissented; projections suggest only one additional rate cut in 2026, although others believe there could be up to two or none [6][5]. This dovish yet measured stance aligns with market scenarios projecting limited rate cuts and a gradual approach toward neutral rates [8].

For investors, this yield curve normalization has several strategic implications. Fixed income investors may favor longer durations again, but must contend with elevated term premia. Equity markets could benefit from improved macro signals, but heightened long yields may weigh on growth-sensitive sectors. Policymakers need to be vigilant: normalization offers relief but does not preclude mid-cycle risks stemming from fiscal disequilibria or supply shocks.