By A recent release of robust U.S. economic data, coupled with statements made by Federal Reserve Chairman Jerome Powell over the weekend, has sent shockwaves through financial markets on Monday. As a result, Treasury yields have surged, reaching some of their highest levels seen this year.
During New York trading, there was a significant sell-off of Treasury bonds across various durations. Yields on 2-year Treasury notes (BX:TMUBMUSD02Y) through to 30-year bonds (BX:TMUBMUSD30Y) experienced substantial increases of around 10 basis points or more each. The benchmark 10-year rate (BX:TMUBMUSD10Y) and its 30-year counterpart reached their highest levels in over a week. Furthermore, the 2-year rate, sensitive to policy changes, was reaching nearly a two-month high.
This sell-off in the bond market was primarily triggered by the reemergence of the “higher-for-longer” theme in interest rates and revised expectations for fewer rate cuts than previously anticipated this year. As a consequence, stock markets were hit hard, with the Dow Jones Industrial Average (DJIA) plummeting as much as 434 points earlier in the day.
Despite the sell-off in equities and U.S. government debt, traders in fed funds futures still hold a cautious stance. They are currently assigning a 55.1% probability of at least five quarter-point interest rate cuts by the Fed before the year ends. In other words, these traders have not completely abandoned the idea of rate cuts in 2024; however, they are now preparing for fewer cuts than initially expected.
The Path to Higher Rates: Market Uncertainty Prevails
Traders and investors are closely watching the trajectory of interest rates, attempting to gauge how “higher for longer” factors will play out in the market. Rob Daly, a seasoned professional overseeing $4.5 billion in fixed-income assets for Glenmede Investment Management in Philadelphia, recognizes the challenge of finding an equilibrium between this pervasive theme and the expectation of fewer rate cuts.
Until recently, the market reflected a 53% likelihood of at least six rate cuts by December according to fed-funds futures traded on the CME FedWatch Tool. However, the sentiment has shifted as traders now remove one of these anticipated cuts from their calculations.
Exciting economic data released on Monday by the Institute for Supply Management and S&P Global indicated that business conditions have exceeded expectations, with continued expansion in January. This positive news follows the surprising nonfarm payroll gain of 353,000 jobs recorded last month and Powell’s recent interview on “60 Minutes.” In the interview, Powell expressed caution regarding rate cuts, citing the strength of the economy and the need for prudence when considering adjustments to the current interest rate range of 5.25%-5.5%.
In a phone conversation on Monday, Daly revised his predictions and now expects the first rate cut by the Fed to take place in June. He is also making preparations for two or three cuts this year, as opposed to his prior estimate of three or four moves. It is worth noting that Fed policymakers have already indicated their intention to implement three quarter-point reductions this year.
A Positive Outlook for the U.S. Rates Strategy
Introducing Subadra Rajappa
In a recent statement, Subadra Rajappa, the head of U.S. rates strategy for Société Générale, expressed her optimism for the current state of affairs. According to her, “All’s well, for now.” This positive sentiment is rooted in the combination of robust data and a consistent disinflationary trend, allowing the Federal Reserve to comfortably avoid hasty cuts.
Maintaining a Balanced Approach
Rajappa’s confidence stems from the Fed’s ability to take a measured approach, thanks to the favorable economic conditions. By not rushing into cuts, the central bank can prioritize stability and evaluate the situation carefully before making any drastic decisions. This luxury is a testament to the strength of the current data and the sustainability of the disinflationary pattern.
As always, it is essential to carefully monitor future developments and remain attentive to any potential shifts in the market. However, for now, the U.S. rates strategy appears well-positioned and poised for further success.
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