Contrary to signaling fiscal weakness, U.S. government shutdowns historically cause Treasury yields to fall. The increased political and economic uncertainty drives a flight-to-safety trade, where investors buy Treasuries as a haven, benefiting the very market tied to the government in turmoil.
Current market chatter about reduced demand for U.S. assets is not a sign of a sudden de-dollarization crisis. Instead, it reflects a slow, rational diversification by global investors who are finding better relative value in other developed markets as their local interest rates rise.
Even if the Fed holds rates steady, front-end Treasury yields are unlikely to rise. Persistent uncertainty in labor market data, combined with the political prospect of a dovish new Fed Chair, will keep an easing premium priced into the market, anchoring short-term yields.
The Treasury is unlikely to make abrupt changes to debt issuance, like cutting long-end auctions, despite political pressure for lower rates. The institutional memory of the 2001 surprise 30-year bond cancellation, which damaged credibility, constrains it to a "regular and predictable" approach to avoid spooking markets.
Recent steepening in the U.S. yield curve is not just due to domestic factors. Fiscal uncertainty in Japan is pushing Japanese Government Bond (JGB) yields higher, making U.S. Treasuries less attractive on a currency-hedged basis for global investors, thus pushing long-term U.S. yields up.