Strong non-farm data drives U.S. bond yields to rebound, but traders remain optimistic about bond market prospects
Traders who are betting that bonds will rise in 2024 are not worried about the recent pullback. On the contrary, they see this as an opportunity to take advantage of rising bond yields (i.e., falling bond prices) before the Fed starts cutting interest rates. Bond prices fell on Friday after U.S. non-farm payrolls data for December was unexpectedly strong. However, as the yield on the 10-year U.S. Treasury note rose to nearly 4.1%, its highest level since mid-December last year, bond buyers flocked to the market, curbing the bond sell-off.
The rally in bonds illustrates a clear shift in market sentiment over the past two months, with investors increasingly confident that the bond market is steadily recovering from its worst downturn in decades, despite data showing continued strength in the U.S. economy. Despite the recent recovery, U.S. Treasury yields remain well below their October peaks as traders bet the Federal Reserve could begin cutting interest rates as early as March.
Priya Misra, a portfolio manager at J.P. Morgan Asset Management, said the 10-year Treasury note “is a buy as long as the yield is between 4% and 4.2%.” He pointed out that before the Federal Reserve’s policy meeting in December last year, the ten-year U.S. Treasury yield was above this range.
The bond market’s rebound in the final two months of 2023 ended its worst decline in decades and fueled traders’ bets that bonds will rise in 2024 and that bond yields will not retest previous peaks. While investors note that yields could move higher if incoming data could change expectations about the Fed’s potential path for interest rates, some large investment firms have been viewing bonds’ recent declines as a good time to buy.
TD Securities strategists said on Friday that while bonds may still fall further in the short term, they still believe the labor market is cooling and the 10-year U.S. Treasury yield will fall to 3% by the end of 2024.
“The bond market is not ready to give up on their optimism that the Fed will cut interest rates this year,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. “The buy-the-dip view is here to stay, and it will take more than just one job to change that.” Notably, not all bonds are seen as immune from losses, and the two-year Treasury note, sensitive to policy rates, could be at risk of repricing if traders further reduce bets on rate cuts due to a strong economy.
The market will face further tests this week: U.S. CPI data for December will be released, and $37 billion of 10-year U.S. Treasury bonds will be auctioned, providing a key indicator of demand. In addition, the speech of New York Fed President Williams also attracted much attention as one of the officials who has recently refuted the market’s response to a sharp interest rate cut at the beginning of this year.
Although the Fed has kept interest rates unchanged since July last year, much depends on whether inflation will continue to fall. Economists surveyed expect U.S. CPI to rise 3.2% year-on-year in December, up from 3.1% in November, but core CPI growth will slow to 3.8% year-on-year from 4%.
Inflation remains above the Fed’s 2% target, but growth has slowed significantly. Additionally, the Fed’s favored inflation measure has grown at an annualized rate of just 1.9% over the past six months, the first time in three years that it has fallen below the Fed’s target.
Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments, said: “Over time, the yield on the 10-year Treasury note may fall below 3.5%, which depends on the decline in inflation levels and the slowdown in economic growth.”
Strategists Ira F. Jersey and Will Hoffman also said: “In the next few months, as the market digests the impact of some interest rate cuts, U.S. bond yields may move higher. But we still believe that by the end of the year, U.S. bond yields will be overall lower in a larger bull market steepening trend.”