(Bloomberg) -- Investors in US government bonds are starting to bet the Federal Reserve will soon need to pivot from worrying about sticky inflation to fretting about slowing economic growth.
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That sentiment helped drive Treasuries to gain for a sixth straight session, which has pushed yields to their lowest levels of the year. Meanwhile, strategists at Morgan Stanley say the 10-year has scope to fall back below 4% if the prevailing view on the Fed shifts somewhat.
Traders this week resumed fully pricing in two quarter-point cuts by the Fed this year, and most of a third one next year, to a level of about 3.65%. Morgan Stanley says if the market prices in a drop to 3.25%, the 10-year can breach 4%. The bank expects inflation data to be released Friday — the prices indexes for January personal consumption expenditures, or PCE — to show a decline in the pace of price growth that could be decisive.
If central bank “rhetoric grows more dovish as a result of better core PCE inflation data, we think that investors will buy more duration – allowing market-implied trough rates to fall further,” Morgan Stanley strategists led by Matthew Hornbach said in a note.
All three of this week’s fixed-rate Treasury auctions drew strong demand, concluding with Wednesday’s seven-year note sale. The $44 billion auction drew 4.194%, lower than its 4.203% yield in pre-auction trading close to the bidding deadline, a sign that demand exceeded dealers’ expectations. Auctions of two- and five-year notes earlier this week produced similar results.
What Bloomberg’s Strategists Say...
“A trade below 4.25%, the next logical and psychological yield support, looks unlikely in the absence of additional fundamental inputs, such as Friday’s PCE data. That said, risk is a breach of 4.25% sparks investor fear of missing out on the rally.”
— Alyce Andres, macro strategist
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The 10-year yield dipped Wednesday to as low as 4.25%. It spent several months below 4% during the second half of last year after notably weak July employment data set the Fed on course to cut rates by a percentage point by year-end.
Then, progress toward lower inflation stalled and the Fed paused in January, saying another rate cut could make things worse. Now, investors see not only in economic growth indicators but also in US fiscal and immigration policies a case for lower yields. Among them are the tariffs US President Donald Trump has been threatening to impose on major trading partners, a strategy that hurt the economy during his first term, alarming Fed policymakers.