Uncertainty over rate cuts wobbles US government bond market
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[April 04, 2024] By
Davide Barbuscia
NEW YORK (Reuters) - Strong economic data and worries over sticky
inflation are pushing investors to reassess how deeply the Federal
Reserve will be able to cut interest rates this year, fueling weakness
in the U.S. government bond market.
Yields on the benchmark 10-year Treasury – which move inversely to bond
prices - hit 4.429% on Wednesday, their highest level in over four
months.
The selloff comes amid a broad shift in sentiment on the timing and
magnitude of expected rate cuts. Futures markets on Wednesday showed
investors are betting the Fed will lower rates by 70 basis points this
year, compared to the 150 basis points priced in at the beginning of
2024.
Notably, investors have become slightly less optimistic on rate cuts
than the Fed itself, which projected to deliver three 25 basis point
reductions this year. Fed Chairman Jerome Powell in a Wednesday speech
maintained that rates will fall later this year, despite
stronger-than-expected growth.
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"The Fed is starting to get ahead of the market because the Fed is
saying ‘we're going to cut’ and the market is saying ‘you don't need to
because economic activity is so strong,’" said Tony Roth, chief
investment officer at Wilmington Trust Investment Advisors.
Bond yields are moving higher for several reasons. U.S. data has
consistently come in stronger than expectations, leading some investors
to believe that the Fed won’t be able to cut interest rates without
risking an inflationary rebound.
The latest evidence of a robust economy came this week, when
stronger-than-expected March manufacturing data was followed by solid
U.S. job openings figures for February and other data pointing to labor
market strength.
U.S. investment management firm PIMCO said in a 6-12 month outlook
report on Wednesday it expects inflation to remain above the Fed’s 2%
target. It still believes the central bank will start cutting rates in
the middle of 2024, but said sticky inflation may lead to a more gradual
path of rate cuts than in other economies.
At the same time, concerns over the state of U.S. finances that helped
drive yields to 16-year highs last October have not dissipated, with
many investors anticipating a rise in term premiums - or the
compensation demanded to hold long-term debt.
The Congressional Budget Office last month forecast U.S. public debt
will climb to 166% of GDP in 2054 from 99% in 2024 - though their
outlook has improved from forecasts made last June due to spending
limits passed by Congress and stronger projected economic growth.
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A trader works on the floor of the New York Stock Exchange (NYSE) in
New York City, U.S., April 1, 2024. REUTERS/Brendan McDermid
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Additional worries over an inflationary rebound could come if oil
prices continue their recent spike. Brent crude settled at its
highest level since October on Wednesday following concerns of a
widening conflict in the Middle East.
Overall, yields on the 10-year have risen by 50 basis points since
the beginning of the year. Some investors have used that as an
opportunity to lock in yields with the hopes that bond prices will
rise as the Fed cuts rates later in the year.
That trade, however, is increasingly becoming a test of patience,
and investors will be closely watching Friday's employment and
consumer price data next week to assess how sustainable the current
selling pressure in bonds is.
Year-to-date total returns - which include bond payouts and price
fluctuations - are at minus 2.1%, according to the ICE BofA 7-10
year Treasury Index.
Meanwhile, net bearish positions in key two- and 10-year Treasuries
futures last week have increased for the first time in three weeks,
according to data by the Commodity Futures Trading Commission.
Kathy Jones, chief fixed income strategist at the Schwab Center for
Financial Research in New York, said she still believes there is an
opportunity to add more duration, or interest rate exposure, if
yields rise further.
However, "it's becoming less of a high-probability trade and more
one that people are going to lose confidence in."
Campe Goodman, lead portfolio manager of the Hartford Strategic
Income Fund, believes the selloff in the bond market is unlikely to
go much further, as higher yields draw income-seeking investors. He
expects 10-year yields to trade between 4% to 4.75% and for
inflation to remain under control.
“We’re not talking about a reacceleration in inflation, we’re
talking about inflation stalling in the 3% range … I’m not that
worried,” he said.
(Reporting by Davide Barbuscia; Editing by Ira Iosebashvili and
Diane Craft)
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