For over a year, bond traders have been whipsawed by uncertainty about how high the Federal Reserve will push interest rates.
But that’s now giving way to a growing conviction that longer-term Treasury yields have likely already peaked — and that unexpected selloffs that give yields a bit of an extra bump up look like good times to buy.
The shift may inject some stability into a bond market that’s been consistently caught off guard by how resilient the US economy has remained as the Fed raised interest rates by five percentage points since March 2022. The dynamic was underscored Friday when bonds slid after a report showed employers unexpectedly accelerated the pace of hiring in May.
At the same time, a slowdown in the pace of wage gains and a rise in the unemployment rate indicated the central bank may finally be guiding the economy to a slowdown, albeit one that it hopes will be relatively gentle. That may effectively put a cap on long-term bond yields even as short-term ones remain volatile while traders try to game out the final plays of the Fed’s policy tightening campaign.
“The 5-year and 10-year have been the sweet spot for us, and we’ve been buying there,” said Scott Solomon, a fixed-income portfolio manager at T. Rowe Price.
The focus is now shifting to the release of the next consumer-price index reading on June 13, when the Fed begins its two-day policy meeting. The gauge is expected to show that the pace of inflation slowed to 4.1% in May from a year earlier, according to economists surveyed by Bloomberg, providing potential support for policymakers to hold off on any further rate hikes until July.
Expectations that the Fed will take such a pause helped send two-year Treasury yields lower ahead of Friday’s employment report, leaving them down slightly on the week around 4.5% despite a steep rebound in the immediate aftermath of the labor market data. Both Fed Governor Philip Jefferson and Philadelphia Fed President Patrick Harker showed support for holding off in some of the final comments from officials ahead of the pre-meeting blackout.
By late Friday, derivatives showed a quarter-point hike this month or next was all but certain, but a less than one-in-two chance it would be at the meeting which ends June 14. Traders have also squeezed out nearly all of the rate cuts that as of last month were still expected during the final stretch of 2023.
The central bank official's new projections for where rates are headed, due to be released at the next Federal Open Market Committee meeting, should reinforce the view that any break in June won’t mean it’s done, particularly if inflation continues subsiding slowly.
“If they really mean they are going to come back after June they may have to signal a little bit higher, probably one more hike in the dot plot,” said Alex Li, head of US rates strategy at Credit Agricole, referring to the nickname for the summary of projections.
Longer-term bonds have been less affected by the speculation about the Fed’s next move, with investors convinced it ultimately doesn’t have much further to go.
Moreover, yields have risen so steeply from pandemic-era lows that they are now providing reasonable income. And there’s potential for fixed-income asset prices to gain if the economy slides into a recession that would push the Fed to reverse course.
That has helped to restrain longer-term yields. When selling pressure was sparked earlier by stronger-than-expected economic figures, buyers swooped in as 5- and 10-year yields rose to their highest levels since the banking turmoil of early March, at 3.99% and 3.86%, respectively. The latest JPMorgan Chase & Co. Treasury client survey showed that long positions were at the highest since last September.
Ten-year Treasury yields ended the week at about 3.69%, down about 10 basis points from a week earlier despite the backup Friday. Five-year yields were around 3.84%.
Jack McIntyre, a portfolio manager at Brandywine Global, said he wasn’t budging his bond-market positioning based on the latest jobs market data. The firm has a high level of holdings in longer-term debt that “will do well in a soft landing and a recession.”
“You want things that are defensive and have yield,” he said.
What to Watch
Economic data calendar
June 5: S&P Global US services purchasing managers index; factory and durable goods orders; ISM services sector indexes
June 7: MBA mortgages; trade balance; consumer credit
June 8: Weekly jobless claims; wholesale trade
Federal Reserve calendar:
Central Bank enters communications blackout ahead of June 13-14 policy meeting
Auction calendar:
June 5: 13- and 26-week bills, 44-day cash management bill
June 7: 17-week bills
June 8: 4- and 8-week bills
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