Traders who have been mired in anxiety about the Fed's interest rate cuts since the beginning of the year, especially those in the bond market, may soon receive some positive signals to support their bullish expectations. First, starting on Wednesday, the US Treasury will launch a series of US bond repurchase programs. The goal of the repurchase is US Treasury bonds that have been issued for a long time and have been undertraded. This will be the first time the Treasury has repurchased them since the beginning of this century. Heavy “support” followed in June, when the Federal Reserve will begin to slow the pace of contraction of its balance sheet as planned, that is, to slow the pace of so-called quantitative austerity (QT). Furthermore, the core PCE inflation data, which will be released heavily this week, is expected to comprehensively strengthen the bullish power of the equity market.
The slowdown in the repurchase and downsizing of US Treasury bonds can be described as a “good backing” for the entire financial market. Both measures will provide important support for the US Treasury bond market, which was once disrupted by the Federal Reserve's hawkish expectations this year, and are expected to continue to drive the “anchor of global asset pricing” — that is, the decline in 10-year US bond yields.
Faced with the continued prosperity and growth of the US economy and surprisingly sticky inflation data for the first quarter, investors fundamentally adjusted their expectations for interest rate cuts, causing the 10-year US bond yield, which has the title of “the anchor of global asset pricing,” to rise sharply in April to the highest point since October. The CME “Federal Reserve Watch Tool” shows that the US Federal Reserve's first interest rate cut at the current rate futures market will be in November or December. The possibility of two interest rate cuts throughout the year is less than 50%, which is significantly smaller than the probability of about 70% in early May.
As can be seen from the “Federal Reserve Watch Tool,” traders' expectations for the Fed's interest rate cut basically hovered around 25 basis points, rather than the 150 basis points traders once generally bet on at the beginning of the year. Economists at Wall Street bank Goldman Sachs once again adjusted their predictions for the Fed's first rate cut last week — the latest forecast is that the Fed will not start cutting interest rates until September of this year; the previous forecast was July. However, Goldman Sachs continues to maintain the forecast that the Federal Reserve will “cut interest rates every quarter or every two meetings,” which means that the timing of the second rate cut was completely postponed from October to December, as previously anticipated by Goldman Sachs. Goldman Sachs's expectation that the Federal Reserve will cut interest rates twice in total in 2024 remains unchanged.
According to some bond traders, the US government's efforts should help improve the US bond market's trading in a stable environment and reduce fluctuations in US bonds. Currently, US Treasury bond prices and treasury bond yield indicators have stabilized after experiencing a series of fluctuations.
Jay Barry (Jay Barry), co-head of US interest rate strategy at J.P. Morgan Chase, said: “Buybacks are of course beneficial and will be a great backing. A slowdown in the Federal Reserve's quantitative austerity will also be beneficial, as this is a prudent risk management measure and should greatly ease concerns similar to the recurrence of the liquidity crisis in the overnight financing market in 2019.”
Since the beginning of May, US Treasury yields have been declining. Yield indicators show that the monthly increase of US Treasury bonds is expected to reach 1.4% this month (the price of US bonds is the exact opposite of the yield trend).
The yield on US 2-year Treasury bonds, which is most sensitive to expectations of the Fed's interest rate cut, closed at around 4.95% last week, close to the upper end of this month's 4.7% - 5.03% range, reflecting mixed economic data and hawkish signals from many Fed officials that they are ready to maintain high interest rates for a longer period of time. Although some Federal Reserve officials have even stated that they are willing to further tighten policies if necessary, the derivatives market and the US bond trading market think this is unlikely, and this trend will help prevent bond yields from breaking through further upward.
In terms of US swap pricing, current swap pricing shows that the Federal Reserve will cut interest rates by about 32 basis points throughout 2024. This data shows that the swap market only expects the Fed to cut interest rates by 25 basis points this year. After the release of lower-than-expected inflation data in April, traders once raised their pricing expectations to about 50-75 basis points, but recently there was a marked decline due to strong PMI data and recently announced lower than expected initial jobless claims.
The US trading market will be closed on Monday for US Veterans Day. The US Treasury's repurchase of treasury bonds will begin on Tuesday.
By the end of July, the Ministry of Finance will purchase some existing government bonds through a series of weekly operations, as well as purchase some bonds that have been issued for a long time, and eventually replace them with larger current treasury bonds. Its purpose is to improve the convenience of transactions and provide liquidity support, as old securities are usually the least liquid targets.
The liquidity of the US Treasury bond market has been challenged many times in recent years, but it has improved this year. J.P. Morgan Chase's indicator of liquidity in the US bond market — market depth — is based on the average size of the three best buy and sell prices in trading between 8:30 a.m. and 10:30 a.m. New York time, and has improved to the level before the Federal Reserve began drastically tightening monetary policy in early 2022. But it's still about 45% below the 10-year average.
Is the upcoming PCE expected to strengthen its bullish power in the stock and bond market? The data may suggest that the Federal Reserve is making positive progress in fighting inflation
The prospect of QT reduction next month also supports the US bond trading market. According to the minutes of the latest meeting, the Federal Reserve will then lower the monthly limit for holding maturing US Treasury bonds without reinvestment from 60 billion US dollars to 25 billion US dollars, while keeping the monthly limit of mortgage-backed securities (that is, MBS bonds) unchanged at 35 billion US dollars.
The US bond trading market is stabilizing within a range as the Federal Reserve has been adhering to a policy of no action for a long time and waiting for high interest rates to eventually slow down the economy. As US bond yields stabilized within the range, the decline in volatility was also a positive factor. The ICE - BofA MOVE Index — a bond volatility index that tracks anticipated fluctuations in treasury bond yields based on options — has fallen to its lowest level since February 2022. Furthermore, after CPI data showed a slowdown in potential inflation in April, the MOVE index showed its biggest continuous decline since June 2023 in the past week.
Neil Sutherland (Neil Sutherland), portfolio manager from asset management giant Schroder Investment Management, said: “US bond yields have fluctuated a lot this year, but people have been relieved since the CPI, which met expectations, was announced in April.” He added that the report suggests that US Treasury yields have reached a high point during the year, and easing volatility is “most important to the mortgage industry.”
This week, the Federal Reserve's favorite inflation data, the core PCE inflation data, will be officially released, and in the opinion of economists, this data is likely to suggest the Fed's positive progress in fighting inflation. Economists generally expect that the core PCE index excluding food and energy will rise 0.2% month-on-month in April. This will be the smallest increase in the index so far this year. The overall PCE price index may rise 0.3% for three consecutive months in April.
In terms of year-over-year data, PCE and core PCE are expected to increase by 2.7% and 2.8%, which is basically the same as last month, rather than PCE continuing to heat up month-on-month and year-on-year in the first quarter.
Goldman Sachs has released a research report predicting that the most popular inflation index for Federal Reserve officials — that is, the core PCE inflation index that excludes highly volatile food and energy components — may rise slightly in the first quarter of 2024, but it will continue to decline for the rest of the year.
With the US Treasury buyback back+QT reduction, it may be difficult for the “anchor of global asset pricing” to rise again
“The US Treasury bond market is likely to rebound before the end of the year as the US economy will slow down from the recent frenzied pace. In addition, the Federal Reserve will cut the scale of the US debt asset divestiture in June, and at the same time, the Treasury will begin liquidity support buybacks. Gradually, liquidity in the US bond market may be strongly supported.” Strategists Ira F. Jersey and Will Hoffman from Bloomberg Intelligence said.
Positions in the US bond market have also become more balanced. The data shows that while deep-rooted long bets are slightly clear, only a few new short bets have appeared. Some investors are watching early June data, including May employment data released on June 7.
From T. Rowe Price's fixed income portfolio manager Stephen Bartolini (Stephen Bartolini) believes that Treasury buybacks will slightly boost transactions, and that reducing the pace of QT by the Federal Reserve will help support the overall liquidity of the economy and banking system. However, what he is most concerned about is the US Federal Reserve's favorite inflation indicator — the core PCE inflation data, which will be released on Friday. The investment manager also expects an annual growth rate of 2.8% in April, which is basically the same as March.
Bartolini said, “Although growth is not that good, it is stable enough, and the continued relative ease of the financial environment will support economic activity. The data continues to support the view that the Federal Reserve will not cut interest rates anytime soon.”
James Camp (James Camp), managing director of the fixed income division of Eagle Asset Management, said, “We think the current yield on US bonds is the second apple for bond buyers.” Eagle Asset Management is a subsidiary of Raymond James Investment Management and manages up to $77 billion in assets. “We will definitely increase the size of our ongoing US debt allocation.”
Although the current yield on 10-year Treasury bonds with a yield of about 4.46% is not as high as the peak of 5% in October last year, some US bond investors believe that as the price volatility of US bonds has declined markedly, current 10-year US bonds are quite expensive to invest in. In particular, they can lock in a yield close to 4.5% when the volatility is significantly reduced.
As full-term US Treasury yields hit their highest level since November last year, particularly the “anchor of global asset pricing” and 2-year US bonds, they are beginning to attract most opportunistic buyers around the world. If we add that the US core PCE in April is in line with expectations, or if it tends to decline from the second quarter, it may push expectations of interest rate cuts back up, which in turn will cause the buying power of US bonds to continue to lower 10-year US bond yields.
Combining factors such as the US Treasury's volatility index and the Treasury's liquidity repurchase support, it is expected that it will be difficult for 10-year US bonds to return to the high volatility trend of April and October of last year, and maintaining a stable trend in 10-year US Treasury yields, which have the title of “the anchor of global asset pricing,” is essential to support the rise in risk assets such as stocks.
From a theoretical perspective, the 10-year US Treasury yield is equivalent to the risk-free interest rate indicator r on the denominator side of the DCF valuation model, an important valuation model in the stock market. There has been no significant change in other indicators (in particular, cash flow expectations on the molecular side). The higher the denominator level or continued to operate at a historically high level, the valuations of risky assets such as high-valued global technology stocks, high-risk corporate bonds, and riskier emerging market currencies are facing a trend of collapse; the opposite is true when the denominator is stable.
Michael Wilson (Michael Wilson), a well-known Wall Street bear and chief stock strategist at Morgan Stanley, currently expects the US stock benchmark index, the S&P 500 index, to rise to 5,500 points by June 2025 (the index closed at 5304 points last week). As the market continued to rise, the strategist's pessimistic expectations for 2023 failed to be realized, and he finally made concessions and raised the target point of the S&P 500 index from 4,500 points to 5,400 points. This made his forecast jump from one of Wall Street's lowest predictions to one of Wall Street's most optimistic expectations for the index to set a new record.
Recently, Deutsche Bank also chose to drastically raise the target point forecast for the S&P 500 index, raising the target price of the S&P 500 index from 5,100 points to 5,500 points. The bullish expectations of the major international bank BMO for the S&P 500 index are as high as 5,600 points. The stock strategist team at Wells Fargo Bank, a major Wall Street bank, recently raised the target price of the S&P 500 index to 5,535 points from 4,625 points previously. Wells Fargo told customers in a report that the potential for growth in corporate performance and significant improvements in profit prospects brought about by artificial intelligence technology, as well as longer time spans and higher valuation thresholds for investors, will all become important upward catalysts for US stocks.