Will the Bond Market Cooling Trend Persist?

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

  • Policymakers pour ‘cold water’ on early rate cuts
  • Economic data is still likely to ‘chill’
  • Watch the quarterly refunding announcement

Hope you are staying warm! This week brought record low temperatures and wind chill advisories across the nation – causing school closures, airport delays, and dangerous travel conditions for millions of Americans. While this should not be surprising given January is traditionally the coldest time of the year, the deep freeze is wreaking havoc for many. The bad news: another artic blast is expected to roll in over the weekend, with temperatures expected to remain below average for much of the U.S. The good news: the cold snap will eventually come to an end. And just like the weather, the bond market is going through its own version of a cold snap, with yields 10-30 basis points higher since the start of the year. Fortunately, like the weather, we do not expect this cooling trend to last. Here’s why:

  • Policymakers pour ‘cold water’ on excessive rate cuts | Treasury yields have steadily climbed since the start of the year, with the 10-year Treasury yield rising back to 4.16% after reaching a low of 3.79% in late December. A retracement after the spectacular rally in the final months of the year was expected. If you recall, we flagged in our December 15 Weekly Headings report that Treasury yields were vulnerable to a mild reversal as we were concerned that the market had gotten ahead of itself pricing in six 25 basis point rate cuts in 2024 according to fed funds futures (nearly double the Federal Reserve’s and our projections). We also worried that any signs of economic resilience could weigh on sentiment. Right on cue, the stronger than expected retail sales report and Fed speakers (Waller, in particular) walking back expectations for a near-term rate cut have dented sentiment and pushed yields higher. However, with Fed rate cuts still on the horizon, we doubt yields will move sustainably higher.
  • Economic data likely to ‘chill’ | The probability of a recession has eased considerably as economic growth remains more resilient than expected. And, while consensus now expects a soft, non-recessionary landing in 2024, our economist still has the 'mildest ever' recession penciled in this year. Why? We expect higher borrowing costs, rising credit card debt and a weaker job market to dampen, but not derail consumer spending. This should drive the economy’s growth rate from a 2.3% pace in 2023 to a below-trend rate of ~1.0% in 2024. It should also drive inflation lower, building a case for less restrictive Fed policy in the coming months. A continuation of this favorable macro backdrop of moderating growth (slowing, but still at a level to avoid a deep recession) and cooling inflation should provide support for the bond market and lead to lower yields in the months ahead.