'Slam dunk' Treasury trade becomes test of patience as yields march
higher
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[February 26, 2024] By
Davide Barbuscia
NEW YORK (Reuters) - A sell-off in the U.S. government bond market is
picking up speed, as a strong economy whittles away at hopes for
imminent interest rate cuts from the Federal Reserve.
Over the last month, investors have roughly halved the number of cuts
they expect the Fed to deliver in 2024, amid booming job growth and
stubborn inflation that have made the U.S. central bank hesitant to ease
monetary policy too soon.
That has exacerbated losses in bonds, complicating the outlook for
investors who had bet Treasuries would rise as the Fed cut borrowing
costs. Yields on the benchmark 10-year Treasury, which move inversely to
bond prices and are guided in-part by interest rate expectations, have
shot to 4.35%, their highest level since the end of November.
"Coming into 2024, nobody thought that inflation could go anywhere but
down. It was a slam dunk that you would win by just positioning in
bonds," said Craig Brothers, senior portfolio manager and co-head of
fixed income at Bel Air Investment Advisors. Now, "that trade is not
working."
Federal funds futures on Friday showed investors pricing in roughly 80
basis points of interest rate cuts this year, compared to some 150 basis
points that had been expected at the beginning of January. Expectations
of when the first of those cuts will come have been pushed to June, from
March.
At the same time, the 10-year Treasury yield is up around 50 basis
points from its December lows. Treasury prices hit a 16-year low in
October only to come screaming back on expectations that the Fed was
done raising interest rates and would move to cutting them this year.
Minutes from the Fed's most recent monetary policy meeting showed
officials concerned about cutting rates too soon and broad uncertainty
over how long the central bank's benchmark overnight interest rate
should stay in the current 5.25%-5.50% range. A chorus of Fed speakers
in recent weeks have reiterated that view.
The Fed's hesitation to ease policy "is going to make it very hard for
rates to fall much further from here, so fast money will have a tough
time holding that position," said Rich Familetti, chief investment
officer of U.S. total return fixed income at SLC Management. "The pain
trade is higher rates and we will likely experience that."
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An eagle tops the U.S. Federal Reserve building's facade in
Washington, July 31, 2013. REUTERS/Jonathan Ernst/File Photo
'MORE VOLATILITY'
Strategists at BofA Securities are among those anticipating further
losses in the bond market. The investment bank earlier this month
said the 10-year yield could rise to about 4.5% in coming weeks as
interest rates did not appear to be "overly restrictive."
Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management,
believes yields could go as high as 4.75% this year. "We are
underweight duration, we think yields can go higher ... and this
will cause more volatility in markets," he said.
Others have been looking at ways to protect against the possibility
of a further decline in Treasuries.
Anthony Woodside, head of U.S. fixed income strategy at LGIMA, has
recommended his clients hedge their bond portfolios with Treasury
Inflation-Protected Securities, which he expects to provide
protection if inflation continues to rise.
Still, there are many who don't believe the selloff in the Treasury
market will last. The U.S. central bank late last year projected 75
basis points of rate cuts this year - a forecast Fed Chair Jerome
Powell said earlier this month was still likely in line with
policymakers' views.
The expected direction of rates is more important than the timing of
rate cuts, said Vishal Khanduja, co-head of the Broad Markets Fixed
Income team at Morgan Stanley Investment Management. He believes the
recent surge in yields is a "mid-cycle correction" and that interest
rates will eventually decline, bolstering the case for owning bonds.
"Even though it's a bumpy road, the direction of travel for
inflation and the Fed is downwards," he said.
(Reporting by Davide Barbuscia; Editing by Ira Iosebashvili and Paul
Simao)
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