(Bloomberg) — Bond traders are bracing for another turbulent week in which key employment data could push the 10-year Treasury yield toward 4%, a level that market watchers say attracts investors to government debt.
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The benchmark U.S. interest rate rose very close on Thursday, rising to 3.89%, after an upward revision to first-quarter U.S. economic growth and a drop in initial jobless claims sparked the biggest Treasury day in more than three months. Yields for most paydays are close to the highest levels seen so far this year, while bets have faded that the Federal Reserve may cut interest rates this year.
A slew of events next week could trigger new bouts of selling and lift yields to 4%, not least of which is the release of the first major economic reports for June – including key labor market data – as well as minutes from the latest Federal Reserve meeting. But for bond investors, the question now is whether yields in the 4% region are attractive, and whether they provide adequate compensation for the risks of the central bank’s failure to control inflation.
Zachary Griffiths, Senior Fixed Income Analyst, CreditSights Inc.
The research firm sees a 50-50 chance of one Fed rate hike at the next policy meeting that ends July 26 — and quarter-point cuts at every meeting in 2024. Even if that scenario doesn’t play out and the Fed is more aggressive, it sees Griffiths said that would limit any selling in long-term Treasury notes.
On the other hand, interest rate strategists at JPMorgan Chase & Co. abandoned their bullish call for Treasuries this week in anticipation of further cuts, with Bill Dudley – former president of the New York Federal Reserve – saying 4.5% was a “conservative estimate” for the peak in the 10-year yields. Years.
It all depends on how many increases the Fed needs to deal with inflation, and whether it can do so without tipping the economy into a painful recession.
The Fed left the interest rate unchanged at 5%-5.25% on June 14 after 10 consecutive increases, as most forecasters expected. The revised quarterly outlook for the economy and monetary policy released that day showed that officials expect to raise interest rates twice more by the end of the year.
Minutes of the June meeting are due for release on Wednesday and may clarify the rationale for the pause, which Fed Chairman Jerome Powell said is appropriate for assessing how higher interest rates are impacting the economy. Trouble appeared in March when several regional banks failed due to losses on their holdings of securities linked to rising borrowing costs, but other indicators – such as those focused on employment – remain strong.
“The market is very focused on labor markets as the thing that needs a weaker break so the Fed can finally get the cycle done,” said Dominique Konstam, head of macro strategy at Mizuho Securities. Clearly, central banks fear that policy will not be restrictive enough to rein in inflation.
However, expectations that the Fed’s tightening cycle sows the seeds of lower inflation helped push long-maturity Treasury yields toward historic lows compared to shorter-maturity yields this week. The two-year yield exceeded the 10-year yield by nearly 107 basis points, within 4 basis points of the largest gap in decades.
The par-inflation rates for Treasury Inflation-Protected Securities — average annual inflation rates needed to equal the higher yields of ordinary Treasury notes — have roughly returned to levels below the 2% that prevailed through 2021. The five- and 10-year parity rates are around 2.2% compared to With 4% year on year CPI in May.
JPMorgan’s weekly survey of Treasury clients this week found the highest level of positive sentiment in more than a decade.
Laird Landmann, co-director of fixed income at TCW Group Inc. The tightening cycle will catch up with the economy. He added, “Further increases in the money rate mean that we have reached a point where more incidents will occur, and this will lead to a slowdown in the US economy or a hard landing.”
For institutional investors such as endowments and pension funds, Treasury yields are currently attractive, Landmann said.
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