Source: Zhitong Finance

As the Federal Reserve and other major global central banks seem to finally begin cutting interest rates as early as June, bond traders are carefully rebetting on positions they had so badly lost a few weeks ago.

Previously, bets on central banks to rapidly ease monetary policy in 2024 had unintended results, as central banks continued to focus on higher-than-target inflation and strong demand. However, the Swiss central bank's unexpected interest rate cut last week and the dovish outlook of Federal Reserve Chairman Powell, Bank of England, and ECB presidents give investors reason to once again prepare for the upcoming easing policy.

For fund managers at institutions such as Pacific Investment Management and BlackRock, and Bill Gross (Bill Gross), the former “king of bonds,” the prospect of falling interest rates is increasing the appeal of five-year or shorter term bonds. As expectations of interest rate cuts heat up, investing in such bonds will reap the greatest benefits.

The superior performance of short-term bonds compared to longer-term bonds is the reason for the so-called steepener (steepener) of the yield curve. Of course, given that inflation remains high and the labor market continues to be strong, the central bank may not be able to once again prove the bullish outlook for short-term bonds.

Jim Reid, head of global economics and subject research at Deutsche Bank, said, “Whether we actually got the price reflection is open to debate. But as far as the current direction of development is concerned, the outlook is the most important thing right now.” He added that although the market is concerned about the “dovish narrative,” it is worth remembering that views on interest rates have changed around 2024. In fact, Jim Reid and his colleagues believe that during this cycle, the market has turned to a dovish policy outlook seven times, but the results of the last six have actually been hawkish.

Currently, investors are feeling what happened at the end of 2023. At the time, the US Treasury bond market seemed to fall for the third year in a row, but as the global market generally expected policymakers to cut interest rates in early 2024, the US Treasury bond market rebounded before the end of last year.

Although the major central banks currently seem to be on the same page, they may eventually act at different speeds, which may present opportunities to make money. Michael Cudzil, portfolio manager at Pacific Investment Management, said, “Major central banks such as the European Central Bank, the Federal Reserve, and the Bank of England will probably all start cutting interest rates in the middle of this year. This is a similarity.” “Interest rate cuts vary in speed and magnitude around the world, which is a good thing for the fixed income market.”

Interest rate traders tend to view June as the beginning of the Fed's easing cycle, after they expected the Fed's easing cycle to begin in March. For the full year of 2024, they expect interest rate cuts to be slightly higher than the 75 basis points expected by Federal Reserve officials. June is also when the market expects the ECB and the Bank of England to start cutting interest rates, and the market has already absorbed the expectation that these two central banks will cut interest rates at least a few times this year.

Strategist Ven Ram said, “If the central banks act in their own way, we may see the Federal Reserve, the European Central Bank, and the Bank of England cut interest rates for the first time before the end of the first half of the year. This means that front-end yields in major economies will continue to fall, and there is no point in fighting central banks.”

Kellie Wood, Schroder's Deputy Head of Fixed Income in Sydney, believes that the dovish stance of most major central banks “makes the bond market likely to be one of the best performing markets this year.” However, she believes there is room for disagreement, especially as the US presidential election is about to be held in November.

Kellie Wood said, “It is very unlikely that the Federal Reserve will cut interest rates by 50 basis points before the November election, but we think this is the best window.” Her portfolio remains neutral on US short-term bonds, while choosing to go long on European short-term bonds and UK Phnom Penh bonds.

It is worth mentioning that although the US Treasury yield curve steepened in the short term after the Federal Reserve announced the interest rate decision last week, the 2-year US Treasury yield is still about 40 basis points higher than the 10-year US bond yield. Since mid-2022, the 2/10 year yield curve has been inverted.

Last week, Federal Reserve officials raised their expectations for inflation and economic growth and reduced their expectations for the number of interest rate cuts in the next two years, making it more complicated for investors to predict the extent of the future economic slowdown. David Rogal, portfolio manager at BlackRock's basic fixed income division, said the revisions to the next two years “indicate that we will enter a shallow easing cycle.” He said that this indicates “some yield curves will get steeper,” so the group reduced its holdings of medium- to long-term bonds.