October 3, 2023

Bond Bulls Ignore Fed-Hike Noise and Continue to Buy Yield Spikes

(Bloomberg) – For more than a year bond traders have been plagued by uncertainty about how high the Federal Reserve will raise interest rates.

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But that is now giving way to a growing belief that longer-term government bond yields have probably already peaked — and that unexpected sell-offs that boost yields look like good times to buy.

The shift may bring some stability to a bond market that has consistently been surprised by how resilient the U.S. economy has remained as the Fed raised interest rates by five percentage points since March 2022. The dynamics were underlined on Friday, when bonds fell after a report. showed that employers unexpectedly accelerated the pace of hiring in May.

At the same time, a slowdown in the pace of wage growth and an increase in the unemployment rate signaled that the central bank could finally lead the economy into a slowdown, albeit one it hopes will be relatively soft. That could effectively cap yields on long-term bonds, even if short-term bonds remain volatile as traders try to play out the last plays of the Fed’s policy-tightening campaign.

“The 5-year and 10-year stretch were the sweet spot for us and we bought there,” said Scott Solomon, fixed income portfolio manager at T. Rowe Price.

The focus now shifts to the publication of the next reading of the consumer price index on June 13, when the Fed begins its two-day policy meeting. According to economists polled by Bloomberg, the gauge is expected to show inflation slowed to 4.1% in May in May.

Expectations that the Fed will make such a pause led two-year Treasury yields to come in lower ahead of Friday’s employment report, taking them slightly lower this week at around 4.5%, despite a strong rebound in the economy. immediate aftermath of labor market data. Both Fed Governor Philip Jefferson and Philadelphia Fed President Patrick Harker showed their support for the postponement in some of officials’ latest comments ahead of the pre-meeting blackout.

By late Friday, derivatives showed a quarter-point gain this month or next was almost certain, but a less than one-in-two chance it would be at the meeting that ends June 14. Traders have also pushed out nearly all of the interest rate cuts expected just last month in the final stretch of 2023.

Central bank officials’ new projections for where interest rates are headed, to be released at the next meeting of the Federal Open Market Committee, should reinforce the view that a June break doesn’t mean it’s done, especially if inflation continues to fall slowly.

“If they really think they’re coming back after June, maybe they should signal a little bit higher, probably another hike in the dotted line,” said Alex Li, head of U.S. interest rate strategy at Credit Agricole, referring to the nickname for the executive summary. the projections.

Longer-dated bonds have been less affected by speculation about the Fed’s next move, with investors convinced it doesn’t have much further to go after all.

In addition, yields have risen so much from pandemic-era lows that they now provide a reasonable income. And it is possible that fixed income asset prices will rise if the economy enters a recession that would prompt the Fed to change course.

That has helped limit long-term returns. With selling pressure fueled by stronger-than-expected economic data, buyers plunged as 5- and 10-year yields rose to their highest levels since the banking turmoil of early March, at 3.99% and 3.86% respectively. The latest customer survey from JPMorgan Chase & Co. Treasury showed that long positions were the highest since last September.

Ten-year Treasury yields ended the week at about 3.69%, about 10 basis points lower than a week earlier, despite the back-up Friday. Five-year returns were around 3.84%.

Jack McIntyre, a portfolio manager at Brandywine Global, said he was not changing his positioning in the bond market based on the latest job market data. The company has a high level of its holdings in longer-term debt that “will do well in a soft landing and a recession.”

“You want things that are defensive and have yield,” he said.

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