Be cautious about betting on rate cuts: US Treasury bonds enter a dangerous period of chasing gains

As of August, US Treasury bond prices have risen for the first time in three years for four consecutive months. Bond market investors continue to bet that the Federal Reserve will soon start cutting interest rates, boosting US bond prices. However, the bond market bulls who continue to heavily bet on rate cuts are now facing risks, as the US economy may not be as weak as traders had thought, and the Fed may not cut rates as significantly as they had anticipated.

On Tuesday this week, the yield on the two-year US Treasury bond, which is sensitive to interest rates, hit a daily low of 3.85%, approaching the low set on August 5th, "Black Monday," since April, falling more than 110 basis points from above 5% at the end of April. US Treasury bonds have gained over 6% in yield since the end of April. Analysts believe that the driver behind this surge in US bond prices is the market's expectation that the Fed will cut rates by a total of over 200 basis points in the next 12 months. This would be the largest rate cut outside of an economic recession since the 1980s.

However, this rebound in US bonds is reminiscent of the rebound at the end of last year, which reversed when the Fed's actions were clearly not as swift and forceful as expected. Analysts believe that for the bond bulls, the current rebound situation poses a risk. If the US labor market, which sharply cooled in July, shows resilience and allows the Fed to cut rates more moderately, the bulls will be in danger. Due to Fed policymakers remaining vigilant about recent inflation increases, the question is whether the weakness in the labor market is sufficient to ensure that the subsequent monetary easing meets market expectations.

Ed Al-Hussainy, a rate strategist at Columbia Threadneedle Investments, commented that it would be somewhat risky to chase the recent rise in US bonds if it had been missed before. "We are considering the possibility of whether the job market will stabilize or deteriorate rapidly. This is the focus of debate for the rest of the year."

Leslie Falconio, Head of Taxable Fixed Income Strategies at UBS Global Wealth Management, stated that UBS believes the market has priced in rate cuts too much and too early. MLIV strategist Simon White mentioned that it is difficult to find reasons for a rate cut of over 200 basis points based on objective data, as the NBER indicator shows a low probability of a recession in the next three to four months. Economic growth is relatively slow, and it would only be reasonable to expect a significant rate cut if there is a rapid market downturn, triggering a feedback loop that leads to a recession.

For bond market bulls, the US non-farm payroll report for August released this Friday will be their first major test. Data shows that over the past decade, September has been the worst-performing month for bond market investors. In eight out of the past ten years, the yield on the ten-year US Treasury bond has risen in September, with an average increase of 18 basis points.

Wall Street News mentioned earlier this month that Bank of America believes the US bond frenzy will quickly reverse. One reason mentioned is that the market expects a 200 basis point rate cut in the next 12 months. Despite the V-shaped recovery of risk assets, the Fed remains as optimistic as possible, and the rate cut has already been fully priced into the market However, overall, Bank of America still maintains a positive stance on US Treasuries, especially believing that going long on 30-year US Treasuries is the best hedging tool against the rising risk of a "hard landing". Therefore, Bank of America believes that the reversal of the rising trend this time is a buying opportunity