(Bloomberg) — Bond traders awaiting the Federal Reserve’s interest rate policy will soon get welcome support.
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Starting Wednesday, and for the first time since the early 2000s, the Treasury Department will launch a series of buybacks targeting seasoned and harder-to-trade debt. Then, in June, the U.S. central bank will begin phasing out the pace of balance sheet unwinding, known as quantitative tightening, or QT.
Both moves will support a Treasury market that has been roiled this year as investors have radically adjusted their expectations for rate cuts in light of continued U.S. growth and surprisingly persistent inflation. The government’s efforts should boost the ability to trade at a time when government bonds have already calmed down, especially after some periods of volatility.
“The buybacks will be useful and provide a good safety net,” said Jay Barry, co-head of U.S. rates strategy at JPMorgan CHase & Co. “And the Fed’s slowdown in quantitative tightening will be helpful as it is prudent risk management that “Allays concerns that we will have a repeat of the 2019 crisis in overnight funding markets,” he said.
Treasury yields have fallen since early May, putting U.S. bonds on track for a monthly gain of 1.4%, as measured by a Bloomberg index.
The U.S. two-year bond ended last week at around 4.95% – at the top end of this month’s range of 4.7% to 5.03% – reflecting some mixed data and signaling a range of Fed officials that they are willing to maintain interest rates. longer higher. And while some central bankers have even signaled a willingness to tighten policy further if warranted, derivatives markets don’t see that as likely, meaning bond yields won’t break out upward.
Read more: Goldman Axes bets on Fed cut in July as market sees less easing
U.S. swap contracts now price in about 32 basis points of Fed rate cuts for all of 2024, reflecting market expectations that just one quarter-point rate cut is a certainty. Traders had pushed prices up to around 50 basis points after the release of softer-than-expected inflation data for April, only to pull back slightly recently.
The US market will be closed on Monday in honor of Memorial Day. Two days later, the buybacks begin.
Through a series of weekly operations scheduled until the end of July, the Treasury Department will purchase some of its existing sovereign debt, buying up older securities and ultimately replacing them with larger current issues. The goal is to increase ease of trading, as older securities tend to be the least liquid.
Liquidity in the government bond market, which has been tested several times in recent years, has improved this year. A JPMorgan Chase & Co. measure of liquidity known as market depth — based on the average size of the top three bids and offers for trades from 8:30 a.m. to 10:30 a.m. in New York — has improved to levels last seen in the early 2022, before Fed tightening began. It is still about 45% below the ten-year average.
Calm down
Lending also offers the prospect of less QT next month. The Fed will lower the monthly limit on the amount of Treasury bonds it allows to mature without being reinvested from $60 billion to $25 billion, while the limit on mortgage-backed securities will remain unchanged at $35 billion.
Read more: Why the Fed is phasing out quantitative tightening: QuickTake
With the Fed on hold and waiting for high interest rates that will ultimately slow the economy, the bond market is in a range and in turn the ICE BofA MOVE Index – a measure of bond volatility that reflects expected swings in interest rates on government bonds based on options – has fallen to the lowest level since February 2022.
MOVE’s decline strengthened last week, with the gauge posting the biggest run of consecutive declines since June 2023, in the wake of consumer price data showing underlying inflation slowing in April.
“There has been a lot of volatility in bond yields this year, and there has been a sigh of relief since the CPI,” said Neil Sutherland, portfolio manager at Schroder Investment Management. The report suggests that government bond yields have reached their peaks for the year, he added, and that the decline in volatility “has been most important for the mortgage sector.”
What Bloomberg Intelligence Says…
“The US Treasury market could rebound by the end of the year as the economy slows from its recent frenetic pace. The Fed will scale back asset outflows in June, just as the Treasury Department will begin buying back liquidity support. Market liquidity could be supported step by step.”
—— Ira F. Jersey and Will Hoffman, BI strategists
Click here to read the full report
Positioning in the bond market has also become more balanced, with data suggesting new short bets have emerged while well-anchored long bets have tapered off somewhat. Some investors are looking at data from early June, including May employment on June 7.
Stephen Bartolini, fixed income portfolio manager at T. Rowe Price, thinks buybacks will marginally help trading and that the Fed’s lowered QT will help support overall liquidity in the economy and banking system. But the most important thing for him is the publication on Friday of the central bank’s preferred inflation gauge, the index of personal consumption expenditure. Interest rates are forecast to have risen 2.7% year-on-year in April, the same as in March.
“Inflation data has proven to be more persistent,” Bartolini said. “And even if growth is not that great, it is solid enough and the continued easing of financial conditions will support activity. The data continues to support the view that the Fed will not cut rates anytime soon.”
While the 10-year yield of around 4.46% is not as high as October’s peak of just over 5%, some investors think they offer value as volatility has fallen significantly.
“Current Treasury yields, in our view, are a second bite of the apple for bond buyers,” said James Camp, director of fixed income at Eagle Asset Management, a subsidiary of Raymond James Investment Management, which manages $77 billion. “We definitely add expensive.”
What to watch
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Economic data:
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May 27: Remembrance Day. Trading on the US markets is closed.
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May 28: house price purchase index; FHFA home price index; S&P CoreLogic; The Conference Board’s Consumer Confidence Report; Production activity by the Dallas Fed
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May 29: MBA Mortgage Applications; Richmond Fed Manufacturing Index and Business Conditions; Dallas Fed Services Activity; Beige book
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May 30: GDP (14); personal consumption; GDP price index; initial unemployment claims; progress in goods trade balance; wholesale/retail supplies; current home sales; current home sales
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May 31: Personal income and expenses; PCE deflator; MNI Chicago PMI
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Fed Calendar:
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May 28: Loretta Mester, president of the Cleveland Fed; Fed Chairman Neel Kashkari of Minneapolis
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May 29: New York Fed President John Williams
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May 30: Williams; Dallas Fed Chairman Lorie Logan
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May 31: Atlanta Fed President Raphael Bostic
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Auction calendar:
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May 28: 13 and 26 week bills; 2-year notes; 5-year notes
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May 29: 17-week bills; Notes with a term of 2 years; 7-year notes
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May 30: 4 and 8 week bills
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–With help from Alexandra Harris.
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