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As Inflation Ebbs, Bonds Will Post Their Biggest Monthly Gain in 2024

June 28, 2024
minute read

US Treasuries are experiencing their most significant monthly rally of the year, driven by a slowdown in the Federal Reserve's preferred inflation measure, which has increased expectations for interest rate cuts starting this year.

Bonds rose on Friday, pushing 10-year yields down by about two basis points to 4.26%, extending a monthly drop to 23 basis points, marking the largest decline since December. Similarly, yields on two-year notes fell by about two basis points to 4.68%, contributing to their overall decline in June. Swaps traders now anticipate around 45 basis points worth of rate cuts this year, with a quarter-point reduction fully expected by November.

The core personal consumption expenditures (PCE) price index, which excludes volatile food and energy prices, rose by 0.1% from the previous month, marking its smallest increase in six months.

"While the data was as expected, the bond market is now well aware of the Fed’s agenda," stated Thomas Tzitzouris, head of fixed-income research at Strategas Securities. "The Fed wants to cut rates and wants to cut soon."

San Francisco Fed President Mary Daly told CNBC that the latest inflation data indicates monetary policy is effective, but it is still too early to determine the appropriate timing for reducing borrowing costs.

The rise in Treasuries came as institutional investors shifted some of their portfolios from stocks following a strong rally in June. The extension of the duration of US bond indexes at month-end may also prompt passive funds to purchase more bonds.

Treasuries have surged since the beginning of May as inflation and the labor market showed signs of cooling. This rally has nearly erased the losses for the year on a Bloomberg gauge of US government bonds.

Friday's PCE report provided encouraging news for Fed officials aiming to initiate rate cuts in the coming months, although they will likely want to see additional data first. Recently, Fed officials reduced their projections for rate cuts this year to just one.

The market has also been adjusting its expectations for the trajectory of monetary policy. Investors began 2024 by pricing in approximately six quarter-point rate cuts for the year but have since reduced those bets to just one fully priced cut.

On Thursday, some traders in the options market linked to the Secured Overnight Financing Rate began targeting two rate reductions this year before the December policy meeting, reflecting a more dovish policy outlook compared to broader market pricing.

"Our house view is that the Fed will deliver the first rate cut in December," said Meghan Swiber, a US rates strategist at Bank of America Corp., prior to the data release. "We have seen an improvement in services inflation figures recently, but the Fed will want to see more persistent improvement."

Swiber is already looking ahead to the employment data reading next week, which she indicated will be crucial for investors in assessing the Fed’s policy direction.

The consistent performance of Treasuries since May, amid signs of cooling inflation and labor market conditions, suggests a more favorable environment for rate cuts. The core PCE index's modest increase supports the view that inflationary pressures are easing, aligning with the Fed’s targets. Institutional investors' strategic shifts and the extension of bond durations further bolster this bond rally.

Overall, while the data and market trends point towards potential rate cuts, the Fed remains cautious, seeking more robust and persistent evidence of inflation and labor market improvements before committing to a definitive rate reduction timeline. The upcoming employment data will be a key indicator for the Fed’s next steps.

Eric Ng
John Liu
Editorial Board
Bryan Curtis
Adan Harris
Managing Editor
Cathy Hills
Associate Editor

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