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Treasury Rally Sends Yields Back Below 4% as Inflation Cools
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Treasury Rally Sends Yields Back Below 4% as Inflation Cools
Michael Mackenzie, Ye Xie and Marquis Emmerson
5 min read
(Bloomberg) -- Short-term US government bond yields fell back below 4% for the first time since October as benign inflation data boosted wagers on Federal Reserve interest-rate cuts.
Yields on two- and three-year Treasury notes fell as much as six basis points Friday, reaching session lows after the Atlanta Fed’s running estimate of US GDP growth declined to -1.5% for the first quarter, from 2.3% on Feb. 26. The latest reading incorporates weaker-than-expected personal spending data for January released earlier Friday.
Traders priced in additional easing by the Federal Reserve this year, and an earlier start. Swap contracts that predict the central bank’s moves fully priced in a quarter-point rate cut by July and a total of more than 60 basis points by year-end.
“I would caution that this is an early read,” said John Brady, managing director at RJ O’Brien. The first full accounting of first-quarter GDP is due out in late April. “Nonetheless, this is helping push two-year yields below 4.00% and 10-year yields below 4.24%.”
The latest yield declines added to the Treasury market’s biggest monthly gain since July. A raft of weak economic growth indicators during the past week revived the case for the Fed to resume cutting interest rates after its recent pause.
The benchmark 10-year note’s yield, less sensitive than shorter-maturity debt to changes in the Fed’s rate, fell as much as 4 basis points to 4.22%, the lowest level since December.
The extensions of the February rally began earlier Friday after the price indexes for January personal consumption expenditures, or PCE, showed deceleration that matched economists’ estimates, offering some relief on the inflation front.
“The move in rates is entirely reasonable thus far given the policy uncertainty,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “For the rally to continue, Tier One economic data needs to suggest that the economy is slowing.”
The drop in yields over recent sessions helped nudge the Bloomberg US Treasury Index higher by 1.7% in February, as of Thursday’s close. It’s also the best start to a year for Treasuries since 2020, with the index up 2.2%.
Now, the focus turns to February employment data to be released next week.
“The evolution of the labor market is going to be a big one,” said Neil Sutherland, portfolio manager at Schroders. “The tradeoff at the moment in the bond market is between the higher inflation and lower growth. And the lower growth dynamic is starting to pull through at the moment.”
It’s a demonstration of how rapidly fortunes can shift in the world’s biggest bond market. Just over a week ago, the 10-year yield was still above 4.5% and seen as likely to entice sellers at that level based on the potential for a trade war to promote inflation.
But since then, a string of softer secondary economic indicators in the US combined with US President Donald Trump’s tariff threats and the elimination of federal government jobs as key drivers.
“The market’s really forward looking here and focusing on the knock-on effects of those government job cuts,” said Brian Quigley, senior portfolio manager at Vanguard. “If they’re cutting spending, they’re cutting funding for other programs, you can have government contractors and the like being negatively impacted as well.”
Meanwhile, tariffs that Trump has said will take effect next week will lead to lower 10-year yields, said Morgan Stanley Investment Management’s CIO of broad markets fixed income, Michael Kushma.
“Markets are more concerned with downside implications for growth than they are about upside inflation surprises,” he said on Bloomberg Television.
What Bloomberg Strategists Say...
“Debt is clearly outpacing stocks this year — fitting right into the set of so-called Trump trades that have fallen by the wayside. Treasuries don’t often enjoy the sort of strong start to a year they are experiencing — 2008, 2016 and 2020 were the only better initial rallies this century.”
— Garfield Reynolds, MLIV Asia Team Leader
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Investors exited bearish positions, and activity in Treasury options featured wagers anticipating the 10-year yield could fall below 4%. Morgan Stanley strategists said such a move was possible if investors come around to the view that the Fed will cut interest rates by another full percentage point, about twice as much as they currently expect. That could happen if hiring trends soften, driving unemployment higher.
For now, the Fed remains sidelined by inflation rates that still exceed its long-term target of 2%. But if it has to choose between supporting growth and fighting inflation, “the Fed will focus on growth,” Quigley said. “Whether they ease or they don’t in a growth scare, the market will price in more aggressive Fed easing.”
A Citigroup Inc. gauge of divergence between the data and economists’ expectations for it this week reached the most negative level since September. The bank’s economists predict the Fed will cut rates in May, by which point they expect that data will conclusively show slowing inflation and growth, and tariff uncertainty will have subsided.
Later Friday, the bond market could find support from month-end buying by index funds and other passive investors. Month-end rebalancing of bond indexes to add securities sold during the month and remove ones that no longer fit the criteria is projected to provide a larger-than-average boost to its duration, a key risk metric, around when the changes take effect at 4 p.m. New York time.
While sellers prepare for the event, it can still lead to higher prices if demand exceeds expectations. The projected duration increase is 0.12 year versus a monthly average of 0.08 year over the past year, related to the large quarterly auctions of new 10-, 20- and 30-year notes and bonds in February.
--With assistance from James Hirai.
(Adds Atlanta Fed economy gauge and updates yield levels.)
