Bond Investors Gain Confidence as Rate Hike Expectations Diminish
Analysis of US Treasuries and Implications for Financial Markets
Bond investors are becoming increasingly optimistic that the relentless sell-off in US Treasuries, which has persisted for months, may finally be drawing to a close.
Signs of Relief
US 10-year yields experienced their most substantial decline since March, driven by dovish remarks from Federal Reserve officials. These comments have fueled speculation that the era of interest-rate hikes may be nearing its conclusion. Additionally, heightened concerns over the Israel-Hamas conflict have bolstered demand for the safety of Treasuries. The magnitude of this move was amplified by the fact that cash Treasuries were unavailable for trading globally on Monday due to a US holiday.
Fed’s Unified Message
Two prominent Fed officials, in their remarks on Monday, conveyed a shared sentiment that the recent surge in US yields may have already accomplished some of the objectives of tightening financial conditions. Andrew Ticehurst, a rates strategist at Nomura Holdings Inc. in Sydney, observed that these Fed speakers emphasized the impact of higher bond yields and tighter financial conditions on their considerations regarding the Fed funds rate. Market pricing now suggests that the Fed is unlikely to raise rates this year, although there remains a possibility of a final “insurance” increase.
Cautious Fed Policy
Fed Vice Chair Philip Jefferson expressed concerns about the rise in Treasury yields potentially further restraining the economy, despite the persistent high inflation rate. Fellow policymaker Lorie Logan indicated that the recent upswing in long-term yields might imply reduced necessity for the central bank to implement further rate hikes.
Meeting-dated swaps currently indicate approximately a 65% probability that the Fed will maintain the status quo in December, compared to just a 60% likelihood of another rate hike by that time, just a week ago. Market confidence extends to the belief that policymakers will abstain from raising rates at any of the other scheduled meetings through mid-2024.
US 10-year yields plummeted by as much as 18 basis points to 4.62%, marking the most significant one-day drop since March 22. Two-year yields also experienced a substantial decline, slipping by up to 16 basis points to 4.92%.
Global Bond Rally
The positive momentum extended beyond Treasuries, triggering rallies in bond markets worldwide. Australian 10-year yields slid nine basis points, while Japanese bond yields dipped by 3.5 basis points, setting the stage for their most significant decline in two months. The decline in Treasury yields also led to a weakening of the US dollar against most of its Group-of-10 counterparts while bolstering Asian stock markets.
Fed’s November Meeting
Market analysts suggest that the Federal Reserve may adopt a cautious tone at the November meeting. This presents an opportunity for the Fed to reiterate that interest-rate cuts are not currently under consideration, dampening investor expectations.
Uncertainties and Skepticism
Nevertheless, uncertainties persist, particularly with escalating events in the Middle East and the recent bond selloff driving long-term yields to multi-decade highs. Policymakers are expected to exhibit reluctance in raising rates under these circumstances.
Bond investors have faced dashed hopes of an end to rate hikes in the past. After a rally following the banking crisis that pushed 10-year yields as low as 3.25% in April, subsequent waves of selling occurred as the Fed continued tightening policy.
The surge in Treasury yields in recent months has been driven by concerns that persistent inflation may lead the Fed to maintain higher borrowing costs for an extended period. A US government debt index has already suffered a 2.6% decline this year, signaling a potential third consecutive year of losses.
Evaluating the Situation
While the recent spike in yields might provide the Fed with additional reasons to exercise caution in the short term, it remains too early to definitively conclude that it marks the end of the economic cycle, as observed by Robert Thompson, a macro rates strategist at Royal Bank of Canada in Sydney.