The US two-year Treasury yield fell to a more than two-year low during the Asia session on Wednesday, after an indicator of consumer confidence slipped overnight, further reinforcing expectations for the Federal Reserve to cut interest rates by 50 basis points at the next meeting.

Market data shows that overnight US bond yields fell across the board. At the end of the New York trading session, the 2-year US bond yield fell by 5.1 basis points to 3.546%, the 5-year US bond yield fell by 3.8 basis points to 3.474%, the 10-year US bond yield fell by 2 basis points to 3.734%, and the 30-year US bond yield fell by 0.7 basis points to 4.087%.

In early intraday trading, the 2-year US Treasury bond yield, most closely related to the Fed rate expectations, further dropped to around 3.51%, hitting the lowest level since September 2022.

The further decline in short-term US bond yields and the escalating market expectations for a significant Fed rate cut are evidently related to the lackluster US economic data overnight. Concerns about the labor market and overall economic outlook contributed to an unexpected largest three-year drop in US consumer confidence in September.

Data released by the World Economic Forum showed that the US consumer confidence index dropped 6.9 points to 98.7 in September, marking the largest decline since August 2021. This was lower than the estimates of all economists surveyed by the media. The future expectations index dropped to 81.7, while the current situation index fell to 124.3.

Analysts point out that the recent slowdown in the US labor market, coupled with persistently high living costs, is pressuring consumer confidence and keeping the index well below pre-pandemic levels. However, the Fed's rate cut last week and the potential for further substantial cuts have already driven down mortgage rates and other borrowing costs, which could support future consumer sentiment.

Data shows that the proportion of consumers in the US who believe there are plenty of job opportunities has been declining for a seventh consecutive month, reaching 30.9%, marking the lowest proportion since March 2021 and the longest continuous decline since 2008. The proportion of those finding jobs hard to come by has risen to 18.3%, the highest level since early 2021.

From the perspective of pricing in the interest rate market, following weaker-than-expected US consumer confidence data on Tuesday, investors are noticeably leaning towards the Federal Reserve cutting interest rates by 50 basis points for a second consecutive time in the interest rate decision on November 7th.

The swap contracts predicting the future actions of the Federal Reserve have fully factored in a scenario of one 50 basis point rate cut and one 25 basis point rate cut in the remaining two meetings of this year, with the probability of a 50 basis point rate cut in November reaching about 60 percent. The CME Group's FedWatch Tool also reflects similar expectations, with the relevant probability being evenly split just a day earlier.

Nathan Thooft, Senior Portfolio Manager at Manulife Investment Management, stated, "We are increasingly inclined towards the camp favoring a 50 basis point rate cut. Although our official stance remains unchanged - that is, rate cuts of 25 basis points each in November and December this year."

However, despite the weak economic data, Federal Reserve Governor Michelle Bowman, the sole dissenter at the September rate-setting meeting who voiced hawkish views, reiterated such sentiments on Tuesday. Bowman stated that inflation risks still exist in the US and the labor market has not shown significant weakness, hence the pace of rate cuts by the Fed should be measured.

She mentioned that her preference for a more measured approach at the start of the easing cycle by the Federal Reserve is based on several considerations. "In my view, initiating the rate cut cycle with a 25 basis point move can better solidify the strong economic momentum, while also confidently confirming that we are making progress towards our goals."

The day before, two other Fed officials - Kashkari and Bostic - both downplayed the possibility of a 50 basis point rate cut next. However, dovish official and Chicago Fed President Evans indicated that rates need to be further cut "substantially".

Looking at the position data, since the last Fed interest rate decision last week, the interest rate market has been gearing up early for the November decision. Open interest in two-year US Treasury note futures has surged, and bets on December futures linked to the Secured Overnight Financing Rate (SOFR) have also increased significantly.

Wells Fargo & Co's macro strategist Angelo Manolatos stated that demand for short-term bonds is generally strong, with investors increasingly "believing that inflation has significantly declined", and some economic growth indicators, including labor market measures, also appear to be slowing down.

"The Federal Reserve cut interest rates by 50 basis points last week and may continue to ease policy by such a large extent. Therefore, from the perspective of investors, the risk of rising interest rates is decreasing, so it looks much better to go long on government bonds," Manolatos pointed out.

Of course, while short-term bond yields are falling, long-term bond yields still remain relatively strong, making the entire yield curve increasingly steeper. Data shows that the spread between the two-year and ten-year US Treasury bond yields, a measure of investors' outlook on the economy, widened to 20.2 basis points intraday on Tuesday, the steepest level since June 2022.

Invesco's head of macro research Rob Waldner pointed out that the Federal Reserve is easing policy, with short-term US bond yields declining, people will see a steepening yield curve. He stated that Invesco currently maintains a tactical short position on 10-year US Treasury bonds and expects long-term bond yields to slightly rise.

In terms of bond auctions, the US Department of the Treasury issued $69 billion of two-year Treasury bonds on Tuesday, with a bid yield of 3.520%, matching the pre-issuance trading level, the lowest bid yield level for two-year Treasury bonds since August 2022. Over the next two days, the US Treasury Department will also continue to auction 5-year and 7-year Treasury bonds.

Editor/ping