(Bloomberg) — Bond traders who are stuck in a waiting game over Federal Reserve rate policy will soon get some welcome support.
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Starting on 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 US central bank is set to begin tapering the pace of its balance-sheet unwind, known as quantitative tightening, or QT.
Both moves will offer support to a Treasury market that’s been upended this year as investors radically readjusted their expectations for rate cuts in the face of persistent US growth and surprisingly sticky inflation. The government efforts should aid the ability to trade at a time when Treasuries have already settled down notably following some pockets of volatility.
“The buybacks will be helpful and will be a good backstop,” said Jay Barry, co-head of US rates strategy at JPMorgan CHase & Co. “And the slowing of the Fed’s quantitative tightening will be helpful as it’s prudent risk management that should allay the concerns that we will have a repeat” of the 2019 crisis in overnight funding markets, he said.
Treasury yields have declined since the start of May, leaving US bonds on course for a monthly gain of 1.4%, as measured by a Bloomberg index.
The US two-year note ended last week at around 4.95% — toward the upper end of this month’s 4.7% to 5.03% range — reflecting some mixed data as well as signaling from a slew of Fed officials that they’re prepared to keep rates higher for longer. And while some central bankers have even indicated a willingness to tighten policy further if warranted, derivative markets don’t see that as a likely, helping to keep bond yields from breaking out on the upside.
Read more: Goldman Axes Bet on July Fed Cut as Market Sees Less Easing
US swaps contracts are now pricing in around 32 basis points of Fed rate cuts for all of 2024, reflecting market expectations for only one quarter-point rate reduction as a sure thing. Traders had pushed their pricing to about 50 basis points after the release of softer-than-expected inflation data for April, only to backtrack a bit more recently.
The US market will be closed Monday in observance of the Memorial Day holiday. Two days later, the buybacks start.
Through a series of weekly operations slated so far through the end of July, the Treasury will buy up some of its existing government debt, purchasing older securities and ultimately replacing them with larger current issues. The aim is to bolster the ease of trading, as older securities are typically the least liquid.
Treasury market liquidity, which has been challenged several times in recent years, has gotten better this year. A JPMorgan Chase & Co. measure of liquidity known as market depth — based on the average size of the best 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 early 2022, before the Fed’s tightening began. It still remains about 45% below its decade-long average.
Calming Down
Also lending support is the prospect of less QT next month. The Fed will lower the monthly cap on how much Treasuries it will allow to mature without being reinvested, to $25 billion from $60 billion, while keeping the cap for mortgage-backed securities unchanged at $35 billion.
Read more: Why Fed Is Phasing Out Quantitative Tightening: QuickTake
With the Fed seen on hold and waiting for high rates to eventually slow the economy, the bond market is settling into ranges and in turn, the ICE BofA MOVE Index — a gauge of bond volatility that tracks anticipated swings in Treasury yields based on options — has slipped to its lowest since February 2022.
The tumble in the MOVE picked up over the past week, with the gauge posting its biggest streak of consecutive declines since June 2023 in the wake of consumer price data showing underlying inflation slowed in April.
“There has been a lot of volatility in bond yields this year, and there was a sigh of relief since CPI,” said Neil Sutherland, portfolio manager at Schroder Investment Management. The report suggests Treasury yields have seen their peaks for the year, he added, and the easing in volatility has been “most important for the mortgage sector.”
What Bloomberg Intelligence Says..
“The US Treasury market may rally by year-end as the economy slows from the recent frenetic pace. The Fed will be cutting asset runoff in June, just as the Treasury Department will begin liquidity support buybacks. Incrementally, market liquidity could be supported.”
—— 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 wagers have appeared amid slight unwinding of well-entrenched long bets. Some investors are looking to early June data, including the May employment on June 7.
Stephen Bartolini, a fixed income portfolio manager at T. Rowe Price, sees buybacks working to marginally help trading and the reduced Fed QT helping to supporting overall liquidity in the economy and banking system. Yet top of mind for him is Friday’s release of the central bank’s preferred inflation gauge, the personal consumption expenditures index. It’s predicted to have risen in April at an annual pace of 2.7%, the same as in March.
“The inflation data has proven stickier,” Bartolini said. “And while growth is not all that great, it’s solid enough and the continual easing of financial conditions, that will support activity. The data keeps on supporting a view that the Fed not going anytime soon and cutting rates.”
While 10-year yields at about 4.46% aren’t quite as high as their peak of just over 5% in October, some investors think they offer value as volatility has fallen appreciably.
“Rates now on Treasuries we see as giving a second bite of the apple for bond buyers,” said James Camp, managing director of fixed income at Eagle Asset Management, an affiliate of Raymond James Investment Management which manages $77 billion. “We are definitely adding duration.”
What to Watch
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Economic data:
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May 27: Memorial Day. Trading in US markets closed.
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May 28: House Price Purchase Index; FHFA house price index; S&P CoreLogic; Conference Board consumer confidence; Dallas Fed manufacturing activity
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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 jobless claims; advance goods trade balance; wholesale/retail inventories; pending home sales; pending home sales
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May 31: Personal income and spending; PCE deflator; MNI Chicago PMI
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Fed calendar:
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May 28: Cleveland Fed President Loretta Mester; Minneapolis Fed President Neel Kashkari
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May 29: New York Fed President John Williams
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May 30: Williams; Dallas Fed President 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-, 26-week bills; 2-year notes; 5-year notes
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May 29: 17-week bills; 2-year floating-rate notes; 7-year notes
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May 30: 4-, 8-week bills
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–With assistance from Alexandra Harris.
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