Investors are grappling with uncertainties in the bond market as fiscal concerns reemerge alongside expectations of a Federal Reserve interest rate cut in the coming months. Despite the bullish consensus that fueled a remarkable bond rally in late 2023, cracks are beginning to surface.
Bullish investors anticipate the bond rally to persist into 2024 if the Federal Reserve adopts an expected monetary policy easing. Futures linked to the Fed’s main policy rate reveal investors pricing in over 150 basis points of cuts, twice the amount projected by policymakers last month.
Contrarily, bears caution against a hasty optimism. They argue that the anticipated surge in U.S. Treasury issuance, set to nearly double to $2 trillion in 2024, could act as a counterforce. The bears contend that yields, which move inversely to bond prices, may need to rise to attract demand for the substantial influx of new debt. Such concerns led to a selloff in Treasury prices in October, pushing them to 16-year lows.
While Treasuries have experienced a modest early-year selloff, with the benchmark 10-year Treasury yields up 16 basis points from December lows, net bearish bets on certain long-term Treasury maturities in the futures market have surged to their highest level since October.
Chris Diaz, portfolio manager and co-head of fixed income at Brown Advisory, highlights the unprecedented U.S. Treasury supply due to a lack of fiscal discipline, expressing skepticism about identifying potential buyers. This surge in supply poses a significant headwind for the long end of the market to sustain its rally.
A BofA Global Research survey indicates a shift in sentiment among investors, with 23% expressing their “highest conviction” trade for 2024 as betting on lower Treasury prices, while 21% favor higher Treasury prices. This reflects a “moderate reversal” of earlier bullish calls on bonds.
Concerns over U.S. debt sustainability heightened in 2023, triggering a bond selloff. A credit rating downgrade by Fitch and increased Treasury issuance plans contributed to the 10-year yield surpassing 5%, its highest since 2007.
As the Federal Reserve considers a potential end to quantitative tightening, JPMorgan analysts suggest this could improve the supply-demand balance in the Treasury market, potentially offsetting rising long-term yields. A return of the Fed as a buyer in the Treasuries market might reshape Treasury issuance, with longer-term debt gaining a larger share.
