Bond Traders Seize on 4% Yields, Confident Fed Rate Cuts Coming

(Bloomberg) — Traders betting on a 2024 bond rally are unfazed by the recent pullback, seeing it as a chance to seize on elevated yields before the Federal Reserve starts driving down interest rates.

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The dynamic was on display Friday, when bond prices dipped after the Labor Department reported that job growth unexpectedly accelerated last month. But the selloff was curtailed because buyers swooped in as 10-year Treasury yields neared 4.1%, the highest since mid-December.

The rebound — even in the face of data showing continued strength in the economy — highlighted the stark shift in sentiment over the past two months, with investors increasingly confident that the bond market is firmly recovering from its worst downturn in decades. Despite the recent backup, yields are still well below October’s peaks as traders wager that the Fed may start easing monetary policy as soon as March.

“Anything between 4% and 4.2% is a buy” for the 10-year, said Priya Misra, portfolio manager at JPMorgan Asset Management, noting that the yield was at the upper end of that range ahead of the last Fed meeting. “For 4.2% to break, we have to bring hikes back in or take out overall cuts.”

The rally that gripped the bond market during the last two months of 2023 put an end to what had been the worst losses in decades, driving Treasuries to a gain for the year and bolstering conviction that yields won’t retest the previous peaks. While investors are mindful that yields may drift higher if incoming data alters expectations about the Fed’s likely path, some big investment firms have been looking at recent drops as good times to buy.

Strategists at TD Securities told clients Friday that while bonds could still slide further in the near-term they remained convinced the labor market is cooling and the 10-year Treasury yield will end 2024 at 3%.

“The bond market is not ready to give up on their optimistic assessment for Fed rate cuts this year,” said Kevin Flanagan, head of fixed-income strategy at WisdomTree. “A narrative of buying on the dips will remain, and it will take more than one jobs report to change that.”

Not all segments of the bond market are seen as sheltered from losses, with policy-sensitive two-year bonds potentially at risk to repricing if traders dial back rate-cut bets further due to the strength of the economy. And the market is facing further tests next week, with the release of the December consumer-price index reading and a $37 billion 10-year Treasury auction that will provide a key gauge of demand. There’s also focus on a public appearance next week by New York Fed President John Williams, who has been among officials recently pushing back on market expectations for steep rate reductions early this year.

But the Fed has held policy steady since July and the December meeting minutes released Wednesday showed that policymakers anticipated that they would likely begin easing this year.

Read More: Fed Sees Rates Staying High for Some Time With Cuts Eyed in ’24

The degree, though, will depend heavily on whether inflation continues to recede. Economists surveyed by Bloomberg expect the consumer price index to show a 3.2% annual rise in December — up from 3.1% a month earlier. But the core measure, which is seen as a better gauge of underlying pressures since it excludes volatile food and energy prices, is expected to have slowed to 3.8% from 4%.

While that’s still above the Fed’s 2% target, the pace has come down significantly. Moreover, the central bank’s preferred gauge rose just 1.9% in November on a six-month annualized basis, the first time in more than three years the measure slipped below the Fed’s targeted level.

“As we go through the course of the year, the 10-year can get below 3.5% and that is dependent on inflation moving lower and growth becoming a little weaker,” said Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments. “A trend of falling inflation and lower growth means the Fed has a framework to be easing and that is likely in the first half of this year.”

What Bloomberg Intelligence Says…

“Treasury yields may move higher over the next few months as the market prices out some of the priced interest-rate cuts, yet we still believe by year end that yields will be lower across the curve in a larger bull-steepening trend.”

— Ira F. Jersey and Will Hoffman, BI strategists

Click here to read the full report

What to Watch

  • Economic data:

    • Jan. 8: New York Fed 1-year inflation expectations; consumer credit

    • Jan. 9: NFIB small business optimism; trade balance

    • Jan 10: MBA mortgage applications; wholesale inventories

    • Jan 11: Consumer price index; jobless claims; real average hourly and weekly earnings; monthly budget statement

    • Jan. 12: producer price index

  • Fed Calendar:

    • Jan. 8: Atlanta Fed President Raphael Bostic

    • Jan. 9: Vice Chair for Supervision Michael Barr speaks on bank regulation

    • Jan. 10: New York Fed President John Williams

    • Jan. 12: Minneapolis Fed President Neel Kashkari

  • Auction calendar:

    • Jan. 8: 13-, 26-week bills

    • Jan. 9: 42-day cash management bills; 3-year notes

    • Jan. 10: 17-week bills, 10-year notes reopening

    • Jan. 11: 4-, 8-week bills; 30-year bonds reopening

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