(Bloomberg) – Bond traders are bracing for another tumultuous week in which key employment data could push 10-year Treasury yields toward 4%, a level market watchers see attracting investors to public debt.
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The U.S. benchmark rate reached a striking distance on Thursday, climbing as high as 3.89%, after an upward revision to U.S. economic growth in the first quarter and a drop in initial jobless claims sparked the biggest day for treasury bills in more than three months. Yields for most tenors approached the highest levels seen so far this year, while bets that the Federal Reserve could cut interest rates this year fell through.
A host of events next week could trigger further waves of selling and lift yields to 4%, including the release of the first major economic reports for June – including key labor market data – as well as the minutes of the last meeting of the Federal Reserve. But for bond investors, the question now is whether yields in the neighborhood of 4% are attractive and whether they provide sufficient compensation for the risk that the central bank fails to control inflation.
The 4% level for 10-year yields “will cause a wave of demand” from investors, said Zachary Griffiths, senior fixed income strategist at CreditSights Inc.
The research firm sees a 50-50 chance of an additional Fed rate hike at the next policy meeting that ends July 26 — and quarter-point cuts at each meeting in 2024. Even if that scenario does not materialize and the Fed is more aggressive, Griffiths sees this limiting any selling of longer-dated Treasuries.
On the other hand, interest rate strategists at JPMorgan Chase & Co. dropped their bullish call on Treasuries this week in anticipation of further decline, and Bill Dudley – a former chairman of the bank of Fed’s New York – said 4.5% was “a conservative estimate.” for peak 10-year yields.
It all depends on how many hikes the Fed needs to bring inflation under control and whether it can do so without plunging the economy into a painful recession.
The Fed left its key rate unchanged at 5%-5.25% on June 14 after 10 consecutive increases, as most forecasters had expected. Revised quarterly forecasts for the economy and monetary policy released that day showed officials expected to hike rates two more times by the end of the year.
Minutes from the June meeting are expected to be released on Wednesday and could clarify the rationale for the pause, which Fed Chairman Jerome Powell said was appropriate to assess the impact of high policy rates on the economy. Signs of trouble emerged in March when several regional banks failed due to losses on their securities portfolios linked to higher borrowing costs, but other indicators, such as those focused on employment, remain robust.
“The market is very focused on labor markets as something that needs to weaken to finally get the Fed really ready for the cycle,” said Dominic Konstam, head of macro strategy at Mizuho Securities. Central banks “are clearly concerned that the policy is not restrictive enough to curb inflation”.
Still, the expectation that the Fed’s tightening cycle is sowing the seeds of lower inflation has helped push long-dated Treasury yields to historic lows against shorter-dated ones this week. . The two-year yield topped the 10-year yield by nearly 107 basis points, within 4 basis points of the widest spread in decades.
Break-even inflation rates for Treasury inflation-protected securities — the average annual inflation rates needed to match the higher yields on regular Treasuries — have almost returned to the sub-2% levels that prevailed. through 2021. The five- and 10-year break-even rates are around 2.2%, compared to 4% over one year for the consumer price index in May.
And JPMorgan’s weekly Treasury client survey this week revealed the highest level of positive sentiment in more than a decade.
“The tightening cycle will catch up with the economy,” said Laird Landmann, co-head of fixed income at TCW Group Inc., a slowdown in the U.S. economy or a hard landing.
For institutional investors such as endowments and pension funds, Treasury yields are currently attractive, Landmann said.
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