US government bonds rallied Friday, adding to their monthly gain, after benign inflation data kept alive predictions that the Federal Reserve will cut interest rates at least once this year.
The data showed that the Fed’s preferred measure of consumer price trends was stable in April at 2.7% year-on-year. Treasury yields across the maturity spectrum declined at least five basis points to the lowest levels of the week as traders added slightly to wagers on a quarter-point Fed rate cut as early as September.
While several pieces of major economic data will be released before the Fed’s next meeting on June 12 — including the April employment report next Friday — policymakers by convention cease commenting starting a full week beforehand, a period that begins this weekend.
“Inflation continues to move in the right direction,” said Jack McIntyre, a portfolio manager at Brandywine Global Investment Management. “As long as the Fed’s next move is to cut rates, you still want to own Treasuries.”
The price index for personal spending, the measure of inflation the Fed aims to have average 2% over time, tumbled from a peak of 7.1% reached in 2022 as the central bank embarked on a series of 11 rate increases. Progress stalled this year, however, leading investors to slash their expectations for how soon rate cuts might begin.
The Treasury market also drew support from expectations that month-end index rebalancing, at 4 p.m. New York time for major dollar-denominated bond indexes, will spur buying by passive investment funds that aim to mimic index performance.
Yields on two-year notes, more sensitive than longer maturities to changes in Fed policy, fell below 4.87% to the the lowest level in more than a week. Two-year Treasury yields approached 5% earlier this week amid signs that ebbing expectations for Fed rate cuts in recent months was hurting demand for sales of new notes and bonds.
“There is really no urgency for the Fed to cut rates this year,” Subadra Rajappa, head of US rates strategy at Societe Generale, told Bloomberg Television after Friday’s data. Still, two-year yields over 5% “would require the Fed to either hike or not cut for the next year.”
Overnight index swaps contracts tied to upcoming Fed policy meetings continue to fully price in a quarter-point rate cut in December, with the odds of a move as soon as September edging up to around 50%. For all of 2024, the contracts imply a total of 35 basis points of rate reductions, up slightly from the close on Thursday.
The month-end rebalancing of bond indexes to incorporate securities created during the month has the potential to spur buying by passive investors.
Auctions held during the month of 10-, 20- and 30-year new issues will contribute to an estimated 0.10-year increase in the duration of the Treasury index. While larger than the monthly average, it’s a smaller increase than has been typical for the month over the past decade, as the Treasury has disproportionately increased auction sizes for its shorter-maturity notes such as the two- and five-year.
The 10-year note’s yield fell below 4.5% Friday after peaking above 4.63% this week. It has spent much of the month hovering around the 4.5% level as softer economic data were offset by comments by several Fed officials appearing to back away from the latest FOMC median forecast of three quarter-point rate cuts this year. That forecast, from March, will be updated at the June 12 meeting.
The Treasury market is set to end May with a gain of about 1.1% — the index return through Thursday — paring its 2024 loss to about 2.2% as measured by a Bloomberg index.
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