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A Week of Whipsawing Treasurys Casts Doubt on Soft Landings

February 4, 2024
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The latest U.S. jobs report, showcasing the strongest performance in a year, has tempered investors' expectations of a significant reduction in interest rates by the Federal Reserve throughout the year. This development marks a shift for those who were anticipating a soft landing for the economy. The data released on Friday revealed that workers' wages are increasing at a rate surpassing economists' predictions, and there are minimal indicators of an economic slowdown.

Earlier in the week, Federal Reserve Chair Jerome Powell indicated that a rate cut in March was improbable, disappointing those who had placed bets on imminent cuts. The anticipation of rate cuts had bolstered bond prices; however, with the new information, bond prices plummeted. Consequently, the 10-year Treasury yield experienced a significant rise from 3.815% on Thursday to 4.030% on Friday – the largest surge since September 2022.

Market participants are now adjusting their expectations, projecting that the benchmark federal-funds rate will end the year around 4.2%. Just a few weeks ago, the consensus was that it would be below 3.9%. Despite a strong start for U.S. stock indexes in the new year, with the Dow Jones Industrial Average up 2.6% and the Nasdaq Composite up 4.1%, concerns loom among analysts and portfolio managers. The worry centers around the potential stalling of further stock advances if the anticipated favorable interest-rate scenario for this year does not materialize.

Steve Sosnick, Chief Strategist at Interactive Brokers, commented on the situation, stating, "If more people are working and they're getting paid more, that doesn't present a great argument for rate cuts."

Simultaneously, investors remain vigilant for any indications of potential market unrest. Historically, developments that threaten turmoil tend to increase demand for ultra-safe Treasurys, consequently pushing yields back down.

Certain sectors are already feeling the impact of the highest interest rates in 22 years. The recent tremors in regional banks have reignited a rally in U.S. debt, reflecting concerns about a potential vulnerability in an economic expansion that has defied expectations with its persistence.

New York Community Bancorp, which acquired the assets of the failed Signature Bank last year, experienced a 42% decline last week after reporting dismal fourth-quarter results. This downturn dragged a KBW index of regional banks down by 7.2%, marking its worst performance since June.

Joseph Wang, Chief Investment Officer at Monetary Macro and a former senior trader at the New York Fed, highlighted the market's reflex to react to trouble in the banking system. This reaction was evident during SVB's collapse last March when investors sought refuge in Treasurys at the first signs of turmoil.

The recent unease in the banking sector has translated into a broader concern, impacting global banks. Shares of several international banks declined due to a deterioration in their loan books, underscoring investors' inclination to turn to bonds as a hedge against potential disruptions.

Anwiti Bahuguna, Chief Investment Officer of Global Asset Allocation at Northern Trust Asset Management, summed up the situation, stating, "Bonds are back because they're a hedge against things breaking." The investor impulse to seek safety in bonds during times of banking-system trouble remains a prevalent trend.


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