The bond market’s bold bet on US interest-rate cuts is set for its biggest test yet.
After loading up on wagers that the Federal Reserve will lower rates by more than 100 basis points in 2024, investors are waiting on tenterhooks to hear Chair Jerome Powell speak Wednesday and see central bank officials’ so-called dot-plot outlining the path of US monetary policy.
While traders trimmed their expectations for cuts in the wake of an inflation report on Tuesday — and recent positioning data suggests some are now more neutral on Treasuries than a few weeks ago — the market remains heavily invested in a Fed pivot. If the message is instead one of higher-for-longer rates, a rapid unwind of those bets will likely follow, spreading pain across the market.
“If we get a message from the Fed that the timing” of expected rate cuts “is simply going to shift, but there is maybe three or four cuts in the cards over the next 18 months, the market can deal with that — and it will deal with that well,” David Lebovitz, global market strategist at JPMorgan Asset Management, said on Bloomberg Television. “What will give the market indigestion is if the Fed sends a hawkish signal that we will not get those three or four cuts.”
Traders were broadly positioned long heading into this week, although some signs have been emerging of a de-risking and liquidation of these wagers. Long positions — predominately built into the front-end of the curve — will face the most risk on Wednesday if Powell forcefully tries to tamp down cuts that are currently priced into the market.
Benchmark two-year yields, those most closely tied to the outlook for US central bank rates, held at 4.72% during European trading on Wednesday, after dropping to as low as 4.63% on Tuesday. Ten-year Treasury yields were down one basis point at 4.19%.
Traders have dialed back the scale of the Fed’s expected rate cuts next year after government data on Tuesday showed the so-called core consumer price index, which excludes food and energy costs, increased 0.3% last month. From a year ago, it advanced 4% for a second month. Economists favor the core metric as a better gauge of the trend in inflation than the overall CPI.
Long-term yields pushed slightly lower again on Wednesday after solid demand at the previous day’s closely watched 30-year bond auction. That eased some of the persistent worries about the market’s ability to absorb the swelling supply of US government debt.
The 30-year debt received a so-called bid-to-cover ratio of 2.43, up from 2.24 at the November auction. The sale was a welcome improvement from an offering of similar debt last month that saw very poor demand. It was also an improvement from Monday when sales of other maturity Treasuries received lukewarm responses.
Despite the volatility in rates, many investors see yields as attractive given their still very high levels, especially with widespread conviction that the Fed’s most aggressive tightening cycle in decades is likely over.
“We are really in a path from the Fed of either a slow cut or a quick cut next year,” Rob Waldner, head of macro research at Invesco said on Bloomberg Television Tuesday. “And both are pretty good for bonds. We think we are in a slow growth, disinflationary, environment.”
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