Policy Divergence and Debt Pressure Intertwined:​Outlook for the Main Trend of European and American Bond Markets in 2026​

The release of the Federal Reserve's December meeting minutes has revealed internal divisions during the monetary policy transition period. Most officials acknowledge room for further interest rate cuts amid falling inflation, while some insist on maintaining the current interest rate level. This divergence essentially reflects differences in perceptions of economic resilience and inflation risks. Although U.S. inflation has declined from its peak, it remains above the 2% policy target. Meanwhile, the cooling labor market and data gaps caused by government shutdowns have further complicated policy judgments.​

Markets have already priced in this divergence, with current trading data indicating that expectations of two interest rate cuts in 2026 remain dominant. The "urgency of rate cuts" emphasized by New York Fed President John Williams stands in stark contrast to concerns about "excessive easing risks" raised by some officials. This tug-of-war has made the short-term policy path more ambiguous and laid the groundwork for bond market volatility.​

The $220 billion Treasury bill purchase plan over the next 12 months disclosed in the meeting minutes may seem like a return to quantitative easing, but it is actually a targeted measure to address money market pressures. Since the summer, the surge in Treasury bill issuance coupled with quantitative tightening has led to a rapid drain of bank reserves. The Secured Overnight Financing Rate (SOFR) has risen 12 basis points above the interest rate on reserve balances, indicating significant pressure on the short-term funding market.​

The Federal Reserve has clearly defined this operation as a "reserve management tool," distinguishing it from stimulus policies. Regarding the implementation pace,

38billioninshort−termTreasurybillshavebeenpurchasedthismonth,withfurtherpurchasestocontinueinJanuaryataninitialmonthlyscaleof

40 billion, which will then be gradually reduced. This gradual approach avoids excess liquidity while repairing market "pipeline" functions to prevent funding pressures from spilling over into the Treasury market. Notably, officials remain divided on tool selection: some advocate strengthening the Standing Repo Facility, while others insist on relying on bond purchase tools, reflecting differing understandings of the definition of "ample reserves."​

Policy signals have directly triggered structural adjustments in the bond market. The U.S. Treasury market has exhibited a typical "short-end decline, long-end rise" pattern: the 2-year Treasury yield fell 0.61 basis points to 3.4484%, reflecting intensified expectations of short-term rate cuts; the 10-year Treasury yield rose against the trend by 1.56 basis points to 4.1258%, highlighting constraints from long-term debt pressures. This divergence has widened the spread between the 10-year and 2-year yields to 33 basis points, continuing the steepening trend that began after the inversion ended in August 2024.​

The collective rise in European bond yields has other drivers. The 10-year yields of Germany, France, and the United Kingdom increased by 2.5, 3.8, and 1.2 basis points respectively. This is partly due to expectations that the European Central Bank will follow the Federal Reserve in easing monetary policy, and partly reflects inflation concerns brought about by energy price fluctuations and fiscal stimulus. Similar to U.S. Treasuries, the rise in European long-end yields is also closely related to the increase in government bond supply, and market concerns about credit spreads are mounting.​

Currently, approximately 9.2trillioninU.S.Treasurybondsaresettomature,accountingforone−thirdofoutstandingbonds.Coupledwitha

1.9 trillion federal deficit, the Treasury Department is facing unprecedented financing pressure. Even with the Federal Reserve's bond purchase plan, annual interest payments exceeding $1 trillion may anchor the 10-year Treasury yield in the 4%-5% range. Calculations by Industrial Research show that if two interest rate cuts are implemented in 2026, the 30Y-10Y spread still has room to steepen by 32 basis points, meaning curve steepening will become the main trend in the bond market.​

For investors, this new normal brings both challenges and opportunities. Bonds with 5-6 year tenors are expected to become yield havens, and high-quality bonds with an expected return of around 4% will be highly attractive amid controlled inflation. However, investors need to be wary of yield spikes triggered by higher-than-expected debt issuance or geopolitical risks. Policy divergence and liquidity volatility will remain core variables in the market.