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Bonds Rise as the Inflation Gauge Maintains Fed Rate-cut Outlook

May 31, 2024
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U.S. government bonds surged on Friday, extending their monthly gains, following favorable inflation data that bolstered expectations of at least one interest rate cut by the Federal Reserve this year.

The data revealed that the Fed's preferred measure of consumer price trends remained stable in April at 2.7% year-on-year. This led to a decline in Treasury yields across various maturities by at least five basis points, reaching their lowest levels of the week. Traders increased their bets on a potential quarter-point rate cut by the Fed as early as September.

Key economic data is still to be released before the Fed's next meeting on June 12, including the April employment report next Friday. However, policymakers will observe a "blackout period" starting this weekend, during which they refrain from public commentary.

"Inflation continues to move in the right direction," commented Jack McIntyre, a portfolio manager at Brandywine Global Investment Management. "As long as the Fed's next move is to cut rates, you still want to own Treasuries."

The personal consumption expenditures (PCE) price index, which the Fed aims to average 2% over time, has dropped from a peak of 7.1% in 2022, following a series of 11 rate hikes by the central bank. This year's progress has stalled, leading investors to lower their expectations for the timing of rate cuts.

The Treasury market was also buoyed by expectations of month-end index rebalancing at 4 p.m. New York time for major dollar-denominated bond indexes. This rebalancing is expected to prompt buying by passive investment funds that seek to replicate index performance.

Yields on two-year notes, which are more sensitive to Fed policy changes than longer maturities, fell below 4.87%, marking the lowest level in over a week. Earlier this week, two-year Treasury yields approached 5% amid waning expectations for near-term Fed rate cuts, which had dampened demand for new notes and bonds.

"There is really no urgency for the Fed to cut rates this year," Subadra Rajappa, head of U.S. rates strategy at Societe Generale, told Bloomberg Television following Friday's data release. She noted that two-year yields exceeding 5% would necessitate the Fed either hiking rates or refraining from cuts for the next year.

Overnight index swaps contracts tied to upcoming Fed policy meetings still fully price in a quarter-point rate cut in December, with the probability of a move as soon as September edging up to around 50%. For the entirety of 2024, the contracts suggest a total of 35 basis points of rate reductions, a slight increase from Thursday's close.

Month-end rebalancing of bond indexes to include securities issued during the month could trigger additional buying by passive investors.

Auctions of 10-, 20-, and 30-year bonds held during the month will contribute to an estimated 0.10-year increase in the duration of the Treasury index. Although this is larger than the monthly average, it is smaller than typical increases for May over the past decade, as the Treasury has disproportionately increased auction sizes for shorter-maturity notes such as the two- and five-year.

The 10-year note's yield fell below 4.5% on Friday after peaking above 4.63% earlier in the week. It has hovered around the 4.5% mark for most of the month, balancing softer economic data against comments from Fed officials who seem to be moving away from the FOMC's March median forecast of three quarter-point rate cuts this year. This forecast will be updated at the June 12 meeting.

The Treasury market is poised to end May with a gain of approximately 1.1%, paring its 2024 loss to about 2.2%, as measured by a Bloomberg index.

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

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