(Bloomberg) — The world’s largest bond market is at an inflection point, with U.S. Treasuries looking to erase losses in 2024 as traders begin to accept the prospect of three interest rate cuts this year.
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Optimism tied to fading inflation was on full display in Treasuries this week, with data expected to back lower borrowing costs as early as September, sending yields lower across the board. The yield on the two-year Treasury note, which is more sensitive to Federal Reserve monetary policy than longer-term bonds, fell 15 basis points this week to 4.45%, its lowest level since March.
“All signs point to the Fed starting to cut rates in September,” said Sinead Colton Grant, chief investment officer at BNY Wealth. “Market participants are reacting to the CPI following the weak June labor market report and Fed Chairman Jerome Powell’s recent testimony before Congress.”
Powell told lawmakers this week that officials are increasingly wary of potential risks to the labor market as they await more evidence that inflation is slowing.Data on Thursday showed that consumer price inflation rose at its slowest rate in three years in June, prompting a rally in bond markets.
Figures released on Friday showed that U.S. producer prices rose slightly more than expected in June, but market participants were more focused on a decline in consumer sentiment. Yields fell broadly on Friday.
This week’s gains helped push the Bloomberg U.S. Treasury Index up 0.3% this year as of Thursday’s close, erasing a 3.4% decline in April since the start of the year.
“Clearly a lot of people are missing out on the high 4.75% yield and there’s a little bit of FOMO, but there’s also growing conviction that the cycle is moving in the direction of lower yields,” said John Magill, senior portfolio manager at Vanguard. “You want to get a lot longer on the curve now that the Fed is stepping in.”
Interest rate swaps showed traders were all but pricing in a quarter-point cut by the September meeting, targeting at least two cuts this year. Barclays economists on Friday revised their forecasts for Fed policy, now forecasting a second cut in December on top of the September cut they already expected.
Some have begun considering the possibility of a half-percentage point cut in September and have bought large amounts of October Fed Funds futures, but this is a price that only makes sense if more people buy into the idea that the Fed could kick off its first easing cycle in years with a mega-cut.
Bloomberg strategists say…
“With gradually weakening economic data and weak CPI readings yesterday, it will be hard for Treasury bears to gain the upper hand. But steepeners are still a trade to watch.”
— Edward Harrison, The Everything Risk newsletter. Learn more about MLIV here.
Traders are now focusing on the release of the Fed’s preferred underlying inflation gauge, the so-called personal consumption expenditures price index, as well as more information on the job market.
“We generally expect rates to continue to fall and ease,” said Molly McGown, interest rates strategist at TD Securities.
Markets are all but certain that the Fed will cut rates in September, but Mohamed El-Erian, president of Queens College, cautioned that the upcoming presidential election could complicate the Fed’s decision. Emboldened by Joe Biden’s poor performance in the debate, former President Donald Trump has floated ideas of imposing high tariffs and cracking down on immigration, both of which are seen as likely to spur inflation.
Politics has been one of the driving forces behind bond markets in recent weeks. Shorter-term bonds have outperformed longer-term ones since the debate, a trend known as a “steepening yield curve,” reflecting concerns that President Trump’s policies could lead to a higher risk premium for long-term Treasuries.
That momentum picked up steam this week as expectations of a rate cut pushed shorter-term yields lower than longer-term ones. The 30-year yield is at 4.4%, about 29 basis points above the 5-year yield and nearing its highest level since February.
“We can’t say investors have strong conviction on duration, but curve steepeners remain a popular trade,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale.
–With assistance from Edward Bolingbroke.
(Adds Barclays forecast and updated prices in 8th paragraph.)
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