Regain lost ground! Expectations of Fed rate cuts rise, US bond prices gradually rise

According to the Zhitong Finance and Economics APP, the US Treasury bonds experienced a roller-coaster ride in the first half of this year and are currently on the brink of breaking even.

Bloomberg's index tracking US bond yields has only fallen by 0.1% so far this year, with a sharp drop of 3.4% in April. The core of this round of rebound in US bonds is that investors are betting that a cooling of US prices will prompt the Federal Reserve to cut interest rates earlier and more aggressively than officials have hinted, effectively limiting the rise in US bond yields.

"We have seen yields peak," said GSFM investment strategist Stephen Miller. "Now, bonds are regaining their rightful place in diversified portfolios."

The US Treasury bond market has experienced ups and downs this year, with the policy-sensitive two-year bond yield soaring to over 5% in April as concerns about keeping US rates high for longer prompted investors to sell bonds. Subsequently, inflation and retail sales data provided support for a Fed rate cut, bringing yields back to around 4.70%.

Interest rate swap traders expect the Fed to cut rates by 25 basis points twice in 2024, with the first cut expected in November. Despite several Fed officials stating on Tuesday that they need more evidence of slowing prices before cutting rates.

Fed Governor Adriana Kugler said that if the economy develops as expected, a rate cut by the Fed "later this year" may be appropriate. St. Louis Fed President Alberto Musalem said in his first major policy speech that it may take "several quarters" to see data supporting a rate cut.

Reduced Volatility

Rachana Mehta, Co-Head of Regional Fixed Income at Malayan Banking Asset Management, believes that the US 10-year Treasury yield is roughly between 4.2% and 4.5%, and when the yield approaches the top of this range, it will be a good time to buy.

Mehta said, "Given recent US data, we hope that the volatility we have seen in the past has disappeared." "You can continue to hold 10-year US Treasury bonds with a yield of 4.4% to 4.5%."

As expectations between the Fed and investors for the number of rate cuts this year begin to converge, the volatility of the $27 trillion US Treasury market has fallen from recent highs. The ICE BofA MOVE index, which tracks option-based expectations of US Treasury yield volatility, is currently hovering around 98, below the high of 121 in April.

"The key is that the gap between the market and the Fed's expectations has narrowed," said Desmond Fu, portfolio manager at Western Asset Management "This reduces volatility."

Not everyone is bullish on US Treasuries. Earlier this month, Barclays strategists recommended shorting the 10-year US Treasury again, as they bet on a rebound in US economic activity after a series of weaker-than-expected data releases.

Focus on Core PCE

Meanwhile, derivatives traders believe that the probability of the Fed cutting rates as early as September is over 60%.

Padhraic Garvey, head of global debt and rate strategy at ING Financial Markets, stated that the market is closely watching the Personal Consumption Expenditures (PCE) price index released on June 28, which is a favored inflation gauge by the Fed. The market expects the index to show "very mild" price pressures in May.

Economists estimate that the annualized growth rate of core PCE in May will drop to 2.6%, the lowest level since 2021.

Garvey said, "This will reinforce expectations of a rate cut in September." He added, "We continue to see 4% as a viable target for the 10-year US Treasury yield."