(Bloomberg) -- Treasuries are poised for their longest monthly winning streak in 14 years as traders bet on more half-point reductions in interest rates as the Federal Reserve aims for a rare soft landing.
US government bonds have so far handed investors returns of 1.2% in September, set for a fifth month of gains that would be the longest run since 2010, according to the Bloomberg US Treasury Total Return Index. The gauge has been rallying since the end of April, extending this year’s gain to 3.8% — and its advance over the past 12 months to nearly 10%.
“Bond markets, in particular, have delivered strong returns,” wrote AXA Investment Managers CIO of core investments Chris Iggo and chief economist Gilles Moec. Those gains are “reflecting the aggressive shift in central bank rate expectations.”
Such a rally has come thanks to the Fed’s hotly anticipated interest-rate cutting cycle. For months, traders and officials scoured economic data for clues on when — and by how much — the central bank should lower borrowing costs from a roughly two-decade high.
Last week, policymakers finally delivered with a half-point reduction and commentary that fueled trader expectations for even more easing ahead as the the Fed aims to keep inflation at bay while preventing a breakdown of the labor market.
The market’s gains extended on Friday as a modest rise in the Fed’s favored measure of underlying US inflation for August reinforced trader expectations that officials will repeat their half-point rate cut at least once more this year. Those wagers will be tested again next week by fresh employment data.
What Bloomberg strategists say...
“Weak personal income and consumption data will give impetus to front-load cutting to a Fed concerned about rates being well above the so-called neutral rate of interest. The expectation of larger cuts will be supportive for longer-dated Treasuries until the US economy is clear of recessionary risk.”
— Read more from Edward Harrison on Bloomberg’s Markets Live blog.
“The rationale for starting with a 50-basis-point cut fundamentally is that policy is too tight,” said Ed Al-Hussainy, global rates strategist at Columbia Threadneedle. “If the logic of the first cut was let’s take some preemptive risk off the table, that logic is going to hold in November, even if the labor market is OK.”
Traders are pricing in about 37 basis points worth of easing by the end of November and roughly 75 basis points of cumulative cuts by the end of 2024. That implies that markets see a 50% chance that Fed officials deliver another half-point reduction at their next policy meeting.
In the world’s biggest bond market, the yield on two-year notes — which is most sensitive to the Fed’s policy — has plunged 147 basis points from the year’s peak of 5.04% in late April to 3.57%. Further out on the curve, the 10-year yield has declined about 95 basis points since late April to 3.75% on Friday, near its 2024 low.
Those moves helped an important segment of the yield curve to normalize in September, with the US two-year note’s yield dipping below the 10-year note’s as traders built up wagers on a super-sized rate reduction this month. This week, the yield curve reached its steepest point since mid-2022.
Still, lingering uncertainty about the scale of the Fed’s coming rate cuts and the rally already seen in Treasuries stands to test the bullish positioning that has accumulated in the market.
Axa’s Iggo and Moec warned that fixed-income returns will moderate into the year’s end “given pricing is now coincident with what most observers suggest could be the level of terminal rates in this cycle.”
Month- and quarter-end pressures, as well as the looming US elections, are also adding to angst among portfolio managers who see risk of choppy trading, Citi strategist Edward Acton wrote in a note. Plus, the final day of each month has become the busiest trading session for Treasuries, according to two New York Fed researchers.
That makes for an action-packed week ahead in bond markets as the calendar flips and traders digest a slew of data on the US labor market. While the release of the September employment report next Friday looms as the key event for traders, there will also be an update on jobs openings, the ADP report on private sector hiring and employment gauges in the ISM manufacturing and service sectors.
(Updates prices throughout.)
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