Bond traders ramped up their bets on an abrupt end to the Federal Reserve’s tightening cycle, pricing in the first interest-rate cut by May as a so-called “melt up” in bond prices continues.
Yields on two-year Treasuries fell as much as 10 basis points on the day. Swap contracts referencing Fed meeting dates repriced to levels consistent with the policy rate declining by a quarter percentage point from its current range of 5.25%-5.5%; a reduction was previously seen happening a month later in June.
A further ginning up of hopes for a swift Fed pivot bolstered US Treasuries, adding to a winning month for holders of US government debt. Multiple block trades supported a steepening of the curve Wednesday, with yields on short-dated Treasuries falling more than those on longer securities; such trades are set to benefit as the US moves closer to rate cuts.
Expectations for the path of the Fed’s policy rate have been shifting downward based on indications that US economic growth is decelerating from its third-quarter pace. Billionaire investor Bill Ackman entered the debate over when the central bank will start easing on Wednesday, saying it could be as soon as the first quarter.
The Treasury market “melt up continues,” said Andrew Brenner, head of international fixed income at NatAlliance Securities LLC. “If more start to believe the Fed is done and focus on the next rate moves — which will be cuts — then there is plenty of firepower to bring rates lower in yield.”
While Brenner cautioned that there is some risk ahead of a rebound given how quickly yields have plunged over recent weeks, trades on Wednesday showed appetite to pile into short-end debt at the expense of the long-end.
A rate cut by May was also briefly priced earlier this year — in September following the release of August employment data — and at least one trader in the options market is positioning for as much as 250 basis points of easing by the Federal Reserve next year.
Fed Governor Christopher Waller helped drive the latest extension in rate-cut bets on Tuesday, when he said current monetary policy looks well positioned to slow the economy and bring down inflation.
Bonds have been on a tear since the 10-year yield briefly surpassed 5% late last month. Benchmark yields have fallen more than 70 basis points since then, and two-year yields are trading at about 4.61% versus a high this cycle of 5.26%. That’s gifting US Treasuries their first solid month of returns following six consecutive months of declines. A Bloomberg US Treasury index was up 3.39% as of Tuesday’s close — gains not seen since a 3.4% rally in August 2019.
Global bonds are also soaring, now at the fastest pace since the 2008 financial crisis. A Bloomberg gauge of global sovereign and corporate debt has returned 4.9% in November, heading for the biggest monthly gain since it surged 6.2% in the depths of the recession in December 2008.
“You’re seeing a complete shift in the narrative,” said Jan Nevruzi, US rates strategist at NatWest Markets. “Once the Fed has adopted the approach that they’ve done enough, there’s not much upside in trying to short the market and fight the Fed.”
--With assistance from Edward Bolingbroke and Garfield Reynolds.
(Updates rates throughout, adds strategist comment.)