Uncertainty over rate cuts wobbles US government bond market
Strong economic data and worries over sticky inflation are pushing investors to reassess how deeply the Federal Reserve will be able to cut interest rates this year, fueling weakness in the US government bond market.
Yields on the benchmark 10year Treasury — which move inversely to bond prices — hit 4.429 per cent on Wednesday, their highest level in over four months.
The sell-off comes amid a broad shift in sentiment on the timing and magnitude of expected rate cuts. Futures markets on Wednesday showed investors are betting the Fed will lower rates by 70 basis points this year, compared to the 150 basis points priced in at the beginning of 2024.
Notably, investors have become slightly less optimistic on rate cuts than the Fed itself, which projected to deliver three 25 basis point reductions this year.
Fed Chairman Jerome Powell in a Wednesday speech maintained that rates will fall later this year, despite stronger-thanexpected growth.
“The Fed is starting to get ahead of the market because the Fed is saying ‘we’re going to cut’ and the market is saying ‘you don’t need to because economic activity is so strong,’” said Tony Roth, chief investment officer at Wilmington Trust Investment Advisors.
Bond yields are moving higher for several reasons. US data has consistently come in stronger than expectations, leading some investors to believe that the Fed won’t be able to cut interest rates without risking an inflationary rebound.
The latest evidence of a robust economy came this week, when stronger-than-expected March manufacturing data was followed by solid US job openings figures for February and other data pointing to labour market strength.
US investment management firm PIMCO said in a 6-12 month outlook report on Wednesday it expects inflation to remain above the Fed’s 2 per cent target.
It still believes the central bank will start cutting rates in the middle of 2024, but said sticky inflation may lead to a more gradual path of rate cuts than in other economies.
At the same time, concerns over the state of US finances that helped drive yields to 16year highs last October have not dissipated, with many investors anticipating a rise in term premiums — or the compensation demanded to hold long-term debt. The Congressional Budget Office last month forecast US public debt will climb to 166 per cent of GDP in 2054 from 99 per cent in 2024 — though their outlook has improved from forecasts made last June due to spending limits passed by Congress and stronger projected economic growth.