Bond Bulls Ignore Fed Hike Noise, Continue Buying Yield Spikes

(Bloomberg) — For more than a year, bond traders have been taken aback by uncertainty about how high the Federal Reserve will push interest rates.

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But that is now giving way to a growing belief that longer-term Treasury yields have likely already peaked – and that windfall selloffs that give yields a little more lift appear to be good times to buy.

The shift could inject some stability into a bond market that has historically been caught off guard by the resilience of the U.S. economy as the Fed has raised interest rates by five percentage points since March 2022. Momentum has been highlighted on Friday, when bonds fell after a report. showed that employers unexpectedly accelerated the pace of hiring in May.

At the same time, a slowing in the pace of wage gains and a rising unemployment rate signaled that the central bank could finally guide the economy into a slowdown, though it hopes it will be relatively mild. This could effectively cap long-term bond yields, although short-term ones remain volatile as traders try to play the final games of the Fed’s policy tightening campaign.

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

The focus is now on releasing the next Consumer Price Index reading on June 13, when the Fed begins its two-day policy meeting. The gauge is expected to show the pace of inflation slowing to 4.1% in May from a year earlier, according to economists polled by Bloomberg, offering potential support for policymakers to delay any further hikes in inflation. rate until July.

Expectations that the Fed will take such a break helped push two-year Treasury yields lower ahead of Friday’s jobs report, leaving them down slightly on the week around 4.5% despite a strong rebound immediately after labor market data. Fed Governor Philip Jefferson and Philadelphia Fed President Patrick Harker both signaled support for the wait in some of the final comments from officials before the blackout ahead of the meeting.

On Friday night, derivatives showed a quarter-point upside this month or next was all but certain, but less than a one-in-two chance at the meeting that ends June 14. . Traders also squeezed out nearly all of the rate cuts that as of last month were still expected in the home stretch of 2023.

New projections from central bank officials on the direction of rates, to be released at the upcoming Federal Open Market Committee meeting, should reinforce the idea that any pause in June won’t mean it’s done, in especially if inflation continues to decline slowly.

“If they really want to say they’re going to come back after June, they might have to signal a little bit higher, probably another rise in the dot chart,” said Alex Li, head of US rates strategy at the Crédit Agricole, referring to the nickname. for the summary of projections.

Longer-dated bonds were less affected by speculation over the Fed’s next move as investors believed there was ultimately little left to do.

Additionally, yields have risen so much from pandemic-era lows that they now provide a reasonable income. And there is potential for fixed income asset prices to gain if the economy slips into a recession that would cause the Fed to reverse course.

This has helped limit long-term returns. When selling pressure was triggered earlier by stronger than expected economic numbers, buyers rushed as 5- and 10-year yields hit their highest levels since the banking turmoil in early March, at 3 .99% and 3.86%, respectively. The latest JPMorgan Chase & Co. Treasury client survey showed that long positions were at their highest since last September.

Ten-year Treasury yields ended the week at around 3.69%, down about 10 basis points from the previous week despite the backup on Friday. Five-year yields were around 3.84%.

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

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

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