(Bloomberg) — Bond traders who are stuck in a wait-and-see mode around the Federal Reserve’s rate policy will soon receive some welcome support.
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Starting Wednesday, and for the first time since the early 2000s, the Treasury Department will launch a series of buybacks targeting older and more difficult to negotiate debts. Then, in June, the U.S. central bank is expected to begin slowing the pace of its balance sheet repair, known as quantitative tightening, or QT.
Both measures will provide support to the Treasury market that has been in turmoil this year as investors have radically readjusted their expectations for rate cuts in the face of persistent U.S. growth and surprisingly stable inflation. The government’s efforts should facilitate trading at a time when Treasury bonds have already stabilized, particularly following certain pockets of volatility.
“The buybacks will be helpful and a good safety net,” said Jay Barry, co-head of U.S. rates strategy at JPMorgan CHase & Co. “And the Fed’s slowing of quantitative tightening will be helpful because it’s prudent risk management that should allay fears of a repeat” of the 2019 crisis in overnight funding markets, he said.
Treasury yields have fallen since early May, leaving U.S. bonds on track for a monthly gain of 1.4%, as measured by a Bloomberg index.
The two-year U.S. bond ended last week at around 4.95% – towards the upper end of this month’s 4.7% to 5.03% range – reflecting mixed data as well as the signal from many Fed officials that they are willing to hold rates. higher and longer. And while some central bankers have even indicated a willingness to tighten policy further if warranted, derivatives markets do not view this as likely, helping to keep bond yields from exploding higher.
Read more: Goldman abandons July Fed taper bet as market sees less easing
U.S. swap contracts now price in about 32 basis points of Fed rate cuts for all of 2024, reflecting market expectations of just a quarter-point rate cut, which is a value safe. Traders had pushed prices up around 50 basis points after the release of weaker-than-expected inflation data for April, only to pull back a bit more recently.
The US market will be closed on Monday for the Memorial Day holiday. Two days later, the redemptions begin.
Through a series of weekly operations planned until the end of July, the Treasury will repurchase part of its existing public debt, purchase older securities and ultimately replace them with larger current issues. The aim is to make trading easier, as the oldest securities are generally the least liquid.
Liquidity in the Treasury market, which has been repeatedly tested in recent years, has improved this year. A JPMorgan Chase & Co. liquidity measure known as market depth — based on the average size of the three best bids and offers for trades between 8:30 a.m. and 10:30 a.m. in New York — has improved to the levels seen for the last time at the beginning. 2022, before the start of Fed tightening. It is still around 45% below its ten-year average.
To calm down
The prospect of a decrease in QT next month also provides support. The Fed will lower the monthly cap on the amount of Treasuries it will allow to mature without being reinvested from $60 billion to $25 billion, while keeping the cap on mortgage-backed securities unchanged at 35 billions of dollars.
Read more: Why the Fed is gradually abandoning its quantitative tightening: QuickTake
As the Fed appears to stagnate and waits for high rates to eventually slow the economy, the bond market is stabilizing in ranges and, in turn, the ICE BofA MOVE Index – an indicator of bond volatility that tracks anticipated fluctuations in Treasury yields based on options – fell to its lowest level since February 2022.
MOVE’s fall has accelerated over the past week, with the indicator posting its sharpest streak of declines since June 2023 following consumer price data showing a slowdown in underlying inflation in April.
“There has been a lot of volatility in bond yields this year, and there has been a sigh of relief since the CPI,” said Neil Sutherland, portfolio manager at Schroder Investment Management. The report suggests that Treasury yields have reached their highs for the year, he added, and that the decrease in volatility has been “most significant for the mortgage industry.”
What Bloomberg Intelligence says…
“The U.S. Treasury market could recover by the end of the year as the economy slows from the recent frenetic pace. The Fed will reduce the asset runoff in June, just as the Treasury Department begins liquidity purchases. Gradually, market liquidity could be supported.
—— Ira F. Jersey and Will Hoffman, BI Strategists
Click here to read the full report
Bond market positioning has also become more balanced, with data suggesting new short bets have emerged amid a slight unwinding of entrenched long bets. Some investors are interested in data from early June, particularly employment data from June 7.
Stephen Bartolini, bond portfolio manager at T. Rowe Price, believes the buybacks will help ease trading slightly and that the Fed’s QT reduction will help support overall liquidity in the economy and banking system. Yet his main concern is Friday’s release of the central bank’s preferred inflation gauge, the Personal Consumption Expenditures Index. It is expected to have increased in April at an annual rate of 2.7%, the same as in March.
“Inflation data has proven to be stickier,” Bartolini said. “And while growth isn’t great, it’s strong enough and continued easing of financial conditions will support activity. The data continues to support the view that the Fed is not going to cut rates anytime soon.
Although 10-year yields, at around 4.46%, are not as high as their peak of just over 5% in October, some investors believe they offer value as volatility has noticeably decreases.
“We view current Treasury rates as giving bond buyers a second bite at the apple,” said James Camp, managing director of fixed income at Eagle Asset Management, a subsidiary of Raymond James Investment Management that manages $77 billion. “We’re definitely adding length.”
What to watch
Economic data :
May 27: Memorial Day. Trading on US markets was closed.
May 28: Housing purchase price index; FHFA Home Price Index; S&P CoreLogic; Conference Board Consumer Confidence; Dallas Fed Manufacturing Activity
May 29: MBA mortgage loan applications; Richmond Fed Manufacturing Index and Business Conditions; Dallas Fed Services Activity; Beige Book
May 30: GDP (14); personal consumption; GDP price index; Initial jobless claims; improve the trade balance of goods; wholesale/retail stocks; pending home sales; pending home sales
May 31: Personal income and expenses; PCE deflator; INM Chicago PMI Index
Fed Timeline:
May 28: Loretta Mester, president of the Cleveland Fed; Neel Kashkari, president of the Minneapolis Fed
May 29: John Williams, president of the New York Fed
May 30: Williams; Lorie Logan, President of the Dallas Fed
May 31: Raphael Bostic, president of the Atlanta Fed
Auction schedule:
May 28: invoices from 13 to 26 weeks; 2-year notes; 5 year notes
May 29: 17-week bills; 2-year variable rate notes; 7 year old tickets
May 30: invoices 4 to 8 weeks
–With help from Alexandra Harris.
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