The Treasury market witnessed a surge in bond prices on Thursday, propelled by a second consecutive day of losses for US financial stocks, reigniting expectations for a swifter pace of interest-rate cuts by the Federal Reserve. US five-year Treasury yields plummeted by as much as 9 basis points to 3.75%, marking the lowest level since June. Concurrently, traders factored in a heightened likelihood of more aggressive Fed rate cuts throughout the year. Swap contracts indicated an increased probability of a rate cut in March, a sentiment that gained traction despite Fed Chair Jerome Powell’s previous remarks suggesting otherwise.
The downtrend in bank shares, triggered by a small New York bank’s unexpected loss announcement and dividend reduction on Wednesday, persisted. This development underscores concerns surrounding US commercial property losses, anticipated to deepen in severity. Investors were reminded of the March 2023 episode, which saw a similar decline in US regional bank shares, prompting a flight to safety towards Treasuries.
Jack McIntyre, portfolio manager at Brandywine Global Investment Management, highlighted the potential adverse effects on banking lending, a vital component of the economy. He noted, “Investors are buying Treasuries first, ask questions later.”
Forecasts that had initially predicted Fed rate cuts commencing in March were reevaluated following Wednesday’s Fed policy meeting. However, swap contracts indicating future Fed decisions now reflect expectations of approximately 150 basis points of easing this year, with the first cut fully priced in for May.
Concerns loom among investors regarding the repercussions of delayed rate cuts on economic growth and inflation, potentially causing the economy to decelerate and undershoot the Fed’s 2% target.
Tim Duy, chief U.S. economist at SGH Macro Advisors, emphasized the significance of Fed policy alignment with market expectations, cautioning that resistance to necessary rate cuts could exacerbate market stress and lead to further declines in long-term yields.
The turmoil in banking stocks persisted, with New York Community Bancorp experiencing a substantial decline, extending its record plunge from the previous day. The broader KBW Regional Banking Index also witnessed a significant two-day drop, echoing concerns over small lenders’ exposure to the commercial real estate market.
The resurgence of banking concerns coincides with the impending closure of the Bank Term Funding Program on March 11, an emergency measure introduced during the March 2023 banking crisis to provide funding support for lenders.
Despite the challenges in the banking sector, broader equity markets remained relatively resilient, with the S&P 500 Index posting a modest gain for the day.
Earlier economic data showed robust labor productivity growth in the fourth quarter, coupled with moderate unit labor cost increases, signaling market expectations of forthcoming rate cuts amid sustained economic strength.
Gennadiy Goldberg, head of US interest-rates strategy at TD Securities, underscored the market’s anticipation of rate cuts, even in the face of robust economic indicators, highlighting the prevailing sentiment of impending Fed action.
