The U.S. government-debt market is drawing to a close on a significant week of trading, characterized by a substantial drop in the 10-year Treasury yield to an 11-week low of 4.2%. This decline follows a four-day rally, triggered by two key economic reports: May’s consumer-price index, which was cooler than expected, and an unexpected drop in producer prices for the same month. These reports overshadowed a hawkish mid-week message from the Federal Reserve and its chairman, Jerome Powell.
Analysts from BMO Capital Markets, Ian Lyngen, and Vail Hartman, described the events of this week as indicative of a clear “regime shift” in the bond market. In parallel, Ralf Preusser and Mark Cabana of BofA Securities suggested that the 10-year Treasury yield could potentially drop as low as 4%, advising investors to “buy on dips.” This week, the yield has fallen by over 20 basis points, marking the largest weekly decline since mid-December, shortly after the Federal Reserve had indicated the possibility of three quarter-point rate cuts for this year.
Gregory Faranello, head of U.S. rates trading and strategy for AmeriVet Securities in New York, summed up the week as extraordinary, noting multiple perspectives emerging from the bond market regarding future interest rates. These perspectives include:
- The necessity for the Federal Reserve to commence rate cuts.
- The possibility of further rate hikes over the next six months.
- The argument for the Federal Reserve to maintain current rates without further action.
Investors and traders in the bond market are realigning their expectations for the Fed’s future rate policy. The recent economic data have introduced the possibility that the Fed might be overly cautious about inflation and may only be able to cut interest rates once this year. As of Friday, fed-funds futures traders were pricing in a 62% chance of a quarter-point rate cut by September and a 72.3% chance of at least two rate cuts by the end of the year.
This rally in U.S. government debt has led to a four-day streak of falling Treasury yields. The 10-year yield, which acts as a benchmark for various borrowing costs in the U.S. economy, was last around 4% in February, amid rising concerns about the conditions of regional banks and the labor market.
A week ago, expectations for any Fed rate cuts this year appeared to diminish following the U.S. economy’s surprising addition of 272,000 jobs in May. At the start of 2024, traders had anticipated as many as six or seven rate cuts throughout the year, but those expectations waned as the months progressed.
The current sentiment among traders is increasingly optimistic, envisioning a “Goldilocks” scenario for the economy. This view posits that inflation can continue to ease while the economy slows down, without triggering a severe recession or significant job losses. This contrasts with earlier expectations, which implied multiple rate cuts and a potential hard landing for the economy. A scenario in which the Fed implements just one or two rate cuts this year suggests that economic growth and corporate earnings could remain stable despite the highest interest rates in 23 years, ranging between 5.25% and 5.5%.
As of Friday, the 10-year yield continued to drift lower, falling by about 2 basis points to just below 4.22%. In parallel, all three major U.S. stock indexes were also trending lower in New York afternoon trading.
This week’s developments underscore the complex dynamics at play in the bond market and the broader U.S. economy. The interplay between economic data, Federal Reserve policy, and market expectations continues to shape the financial landscape, highlighting the challenges and uncertainties that investors and policymakers must navigate. The bond market’s response to economic indicators and Fed communications will be critical in determining the path forward for interest rates, economic growth, and market stability.