Treasury Yields Slide as Softening US Data Affirms Bond Bulls
By: Michael MacKenzie and James Hirai
(Bloomberg) — US Treasuries added to their historic new- year advance Wednesday as five- and 10-year yields dropped to the lowest levels since September. The main catalyst was a spate of weaker-than-expected US economic data that reinforced expectations the Federal Reserve will soon end its run of interest-rate hikes.
The downside surprises in retail sales, producer prices and industrial production reignited a rally that began during Asia’s trading day after the Bank of Japan maintained its accommodative policy stance, catching some traders by surprise. Strong demand for an auction of 20-year bonds cemented the gains. Intermediate sectors of the Treasury market led yields to levels consistent with the view that a US economic recession arriving later this year could compel Fed rate cuts. The five- year yield fell as much as 19 basis points to 3.43%, the 10-year as much as 18 basis points to 3.37%, on heavy volumes in Treasury futures. Benchmark yields were near session lows shortly before 4 p.m. New York time.
“The impact of a year of very aggressive central-bank tightening and quantitative tightening are starting to bite the economy and they are biting hard,” Bob Michele, chief investmentofficer at JPM Asset Management told Bloomberg Television. “Investors are making the decision: get into bonds.”
Related story on dollar dropping to lowest level since April Expectations for the Fed’s policy rate peak by the middle of the year eased below 4.9%, while swaps covering the next twopolicy meetings out to March priced in 46 basis points of additional tightening. The Fed’s current policy band is 4.25% to 4.5%. The gains failed to curb demand for the 20-year bond auction, which drew a yield of 3.678%, the lowest since August, versus a pre-sale level of around 3.705%, a sign that demand exceeded expectations. After the auction, the Fed’s Beige Book report characterized economic activity as broadly unchanged or stagnant, helping sustain market gains.
Treasuries may face resistance as the 10-year yield approaches 3%, said Gregory Faranello, Head of US Rates Trading and Strategy for AmeriVet Securities. “The market is getting to levels — where even with the economy weakening — some accounts may start to ask whether a rethink on rates makes sense,” he said.
St. Louis Fed President James Bullard, in an online Wall Street Journal interview Wednesday, said rates have to rise further to ensure that inflationary pressures recede.
Further rate hikes are seen maintaining a deeply inverted Treasury yield curve. A New York Fed model measuring the probability of recession based solely on the spread between 3-month and 10-year Treasuries as of last month showed the highest probability of recession since the early 1980s, and the curve inversion has intensified by ~75 basis points during 2023, with 3-month bills yielding around 1.3 percentage points above the 10-year.
The rally in Treasuries extends the market’s strong start to 2023, with a broad Treasury index up 2.2%. “Treasuries are a haven as growth slows down,” said Monica Defend, head of the Amundi Institute. “They provide attractive carry and still have space to rally.” Amundi expects the Fed policy rate reaches 5.25% this year and the central bank stays on hold as “inflation is not slipping back to 2%,” and “the curve will be very inverted,” said Defend.