Source: Zhitong Finance

US debt investors, who have once again been hit hard by strong US economic data, now hope to be supported by clear and definitive economic data rather than controversial data to prove that the Federal Reserve is about to cut interest rates for the first time since starting a cycle of interest rate hikes, and then drastically increase US debt of various maturities. The buying power of US bonds seems to have recently turned to “leaving the market and watching”. According to well-known institutions such as TD Securities, the yield on 10-year US bonds, which have the title of “the anchor of global asset pricing,” may hit the 5% critical mark again after a lapse of many months, thus continuing to suppress the trend of risky assets such as stocks.

Economic data such as America's resilient GDP growth data, sticky inflation, and the number of employed people have hit interest rate cuts once again hard recently. Swap traders generally expect that the Fed will cut interest rates by only 25 basis points in 2024, while 50 basis points have become relatively optimistic expectations.

Last week, US Treasury yields for various matures soared to the highest level in the year, after traders unexpectedly experienced three consecutive months of sticky inflation data. The shock in the US bond market has been accompanied by a large wave of new short positions, and more and more long traders are becoming cautious. Demand for the US Treasury's recent sale of long-term bonds was weak, further confirming the overall bearish sentiment in the market.

“Bearish forces currently control the entire US debt market.” Andrew Brenner, head of international fixed income from NatAlliance Securities LLC, said. “We need data to support the view that the benchmark interest rate needs to be lowered.”

As expectations of the end of 2023 and the beginning of this year betting on the Federal Reserve's policy shift to easing continued to heat up, the interest rate futures market at the beginning of this year bet that the Fed would cut interest rates by 150 basis points this year. Supported by strong buying power and expectations of interest rate cuts, global bond investors experienced a slight positive return on bond prices after 24 months of continuous decline during the “bond frenzy” wave at the end of last year.

However, as inflation data that exceeded expectations for 3 consecutive months continued to highlight the flexibility and inflationary stickiness of the US economy, the interest rate futures market's interest rate cut was once as low as 25 basis points, far from the 150 basis point forecast at the beginning of the year and the 75 basis points before the CPI was announced, and the timing of the market's first rate cut was drastically delayed from March to November, later than June, when the market bet on the eve of the CPI announcement. It is enough to see that the bearish sentiment on US debt and other sovereign bonds is fully returning.

The US bond market's aggressive expectations that the US benchmark interest rate will remain “higher-for-longer” (higher-for-longer) (higher-for-longer) are fermenting. As of last Thursday, the high 4.2% price return on the global sovereign debt index since 2023 has been completely erased. The yield on 10-year US bonds, which have the title of “anchor of global asset pricing”, was close to 4.6% last week. According to the latest data, as of last Thursday, the “Global Government Sovereign Bond Price Index” compiled by Bloomberg has fallen 4.7% this year.

Safe-haven demand is expected to boost US debt in the short term, but economic fundamentals do not support the continued decline in US bond yields

The relatively positive news in the US bond market is that US Treasury bond prices ended a continuous decline last Friday, and yields fell sharply. Mainly due to geopolitical tension in the Middle East stimulating short-term safe-haven needs of investors around the world, US bond prices have rebounded across the board.

Iran's unprecedented attack on Israel on Saturday has heightened anxiety — yet, although any further escalation could spawn safe-haven demand for US Treasury bonds, the current fundamentals of the US economy are more in line with an environment where interest rates have remained high for a long time and bonds are under pressure. Without compelling evidence of change, few investors seem willing to go against the trend.

As early as the beginning of this year, the interest rate futures market anticipated that the Fed would cut interest rates as many as 6 times in 2024, or cut interest rates by a total of about 150 basis points, but now traders doubt whether the Fed will cut interest rates by 50 basis points is already a big question mark. Most Wall Street economists have also lowered their expectations for US Treasury yields, and some economists even think that the 10-year US Treasury yield may once again break through the 5% mark, as in October last year.

The readjustment of interest rate cut expectations can be described as very cruel to bond trading. According to the Bloomberg Index, the US Treasury Bond Price Benchmark Index has already fallen by about 0.6% last week, and has fallen by about 2.6% so far this year. This is equivalent to more than half of the 4.1% increase in the Bloomberg US Treasury Index in 2023.

Even after experiencing a sharp upward trend last Friday, the 10-year Treasury yield closed at 4.52% last week, and the expected 4.5% level buying force either did not appear, or at least not enough to withstand heavy selling pressure.

Thierry Wizman, a global currency and interest rate strategist from Macquarie Group, said: “As the US disinflation (disinflation) trend is well above the 2% target anchored by the Federal Reserve for three consecutive months, traders are adapting to this outlook, that is, the 'last mile' of the anti-inflation trend is difficult to achieve.” He added that considering the current situation, the 10-year US Treasury yield rose to 4.75% “doesn't seem too exaggerated.”

Boston Federal Reserve Chairman Collins said on Friday that it may take more time than previously anticipated to gain confidence to begin easing monetary policy, and reiterated his previous views. A day ago, his colleague John Williams (John Williams), Chairman of the New York Federal Reserve and FOMC Permanent Voting Commissioner, said that there is no clear signal to adjust monetary policy in the short term.

The 2024 FOMC voting committee and San Francisco Federal Reserve Chairman Daly said on Friday that the US economy and policy interest rates are currently in good condition, and interest rate cuts are not urgent. Before deciding whether to cut interest rates, she needs to be fully convinced that inflation can be reduced to 2%. She stressed that there is still a lot of work to be done before the Fed can be confident. She said that we should not be surprised by the tortuous path of inflation falling back, and the Federal Reserve needs to move as gently as possible towards the goal of returning inflation to 2%.

Will the “anchor of global asset pricing” set off another storm?

The 2-year US bond yield, which is most sensitive to interest rate expectations, once rose above the 5% mark in US stock trading on Thursday. For the first time since November last year, the 10-year US bond yield, which has the title of “anchor of global asset pricing,” once soared to 4.59% last Thursday.

According to TD Securities, the 10-year US Treasury yield could reach 5%, or even higher. Prashant Newnaha, a strategist at TD Securities (TD Securities), is a bearish predictor that the price of US bonds may fall further. The strategist based in Singapore said, “Our feeling is that unless the Federal Reserve officials change their positions to liberals and let the risk market take notice, there is still more room to sell off fixed income assets. It's not impossible for the US 10-year Treasury yield to rise to 5% or more.”

Kellie Wood, Schroder's Deputy Head of Fixed Income in Sydney, said: “I don't think it's impossible for 10-year US Treasury yields to reach 5% or more.” Wood pointed out that the company is still preparing for “the possibility that the Federal Reserve will not cut interest rates at all this year.”

Shaan Raithatha, a senior economist from Pioneer Group, a top US asset management company, recently said that the agency's basic assumption is that the Federal Reserve will not cut interest rates in 2024.

In October 2023, the “anchor of global asset pricing” once rose above the landmark integer mark of 5% and soared to the highest level since 2007. The 10-year US bond yield completely disrupted the global risk asset trend in the second half of 2023. Now, the 10-year US bond yield has regained an upward trend, causing the market to worry about whether it will once again hit the price of risky assets such as stocks and cryptocurrencies hard.

From a theoretical perspective, the 10-year US Treasury yield is equivalent to the risk-free interest rate indicator r on the denominator side of the DCF valuation model, an important valuation model in the stock market. There have been no significant changes in other indicators (in particular, cash flow expectations on the molecular side). Even when the April US stock earnings season may be biased towards a downward trend, the higher the denominator level or continued to operate at historically high levels. Valuations of risky assets such as high-valued global technology stocks, high-risk corporate bonds, and riskier emerging market currencies are facing a trend of collapse.

This week, investors in US debt will learn about the latest US consumer spending situation and the latest statistics on the performance of the real estate market while mortgage interest rates remain high from the latest US retail sales data report, which has the title of “horror data.” US retail sales data generally have a big impact on the financial market, mainly because consumption-related projects account for up to 70% to 80% of US GDP.

The market will also focus on the performance of some of Wall Street's largest commercial banks, such as Goldman Sachs (GS.US) and Morgan Stanley (MS.US). On Friday, J.P. Morgan Chase (JPM.US) announced a full-year net interest income forecast lower than market expectations, spurring the company's stock price to drop sharply on Friday.

The minutes of the US Federal Reserve's March meeting released last Wednesday highlight that Fed officials are unwilling to cut interest rates unless they have more data showing that inflation is steadily moving towards 2%. At the same time, there are growing voices questioning whether the Federal Reserve, despite its aggressive austerity cycle, is strict enough to curb the overheated job market and strong wage growth in the service sector.

Many traders now believe that the so-called “neutral interest rate” that neither stimulates nor limits the economy — will be much higher than pre-COVID-19 levels in the long run. Derivatives traders generally expect that in the next three years or so, the US benchmark interest rate will hover at a high level of slightly below 4%, which is far higher than the median long-term interest rate forecast of 2.6% fixed by Federal Reserve officials in the general sense.

Bloomberg Intelligence economists Ira F. Jersey and Will Hoffman said: “After the US released better-than-expected March CPI data and neutral minutes of the Federal Reserve meeting, the interest rate market was repriced to a new range. The market is beginning to hedge against the risk that interest rate hikes may be the next policy action by the Federal Reserve, and 2-year US Treasury yields may have underestimated the more symmetrical results.”

In an interview on Friday, the Federal Reserve's Collins said that current long-term interest rates are likely to be higher than in the past, adding that she is studying this topic with her team to form a more clear opinion. “This is something we'll be focusing on for a long time because it's an important issue.”

Brenner from NATAlliance said that Federal Reserve Chairman Powell and other policy makers may be under pressure to cut interest rates at least once before the US presidential election in November. They don't want to appear politicized, but strong economic data continues to emerge, making matters complicated. “Obviously Powell wanted to relax and was looking for cover — but he couldn't find it,” he stressed.

Although many analysts expect that upcoming Fed speakers will lean towards a tougher tone given the troubling trend in inflation, some traders are unwilling to use funds to support the actions that Fed officials have to take in the face of all the apparent reversals. For some agencies, there is a clear sense of deja vu.

“As soon as you see flexible data released, there will be more questions about changes in the Fed's policy interest rate path,” said George Catrambone, head of the fixed income department at DWS Americas. “It feels a bit like going back to 2023 — no recession, no soft landing, all you have to do is hold the cash.”

edit/lambor