The market’s optimistic consensus for bonds is beginning to show cracks as expectations that the Federal Reserve would lower interest rates in the upcoming months are offset by resurrecting budgetary concerns.
Demand For Influx
Bullish investors think that, if the Fed eases monetary policy as anticipated, the spectacular rally that bonds saw in late 2023 will probably continue into this year. Investors priced in more than 150 basis points of cuts in futures linked to the Fed’s main policy rate on Friday, which is twice as much as policymakers had predicted just a month ago.
The bears say, not so fast. Although bond prices are now being driven by expectations for Fed easing, others think that U.S. Treasury issuance, which is predicted to nearly double to $2 trillion in 2024, could act as a counterbalance.
In order to stimulate demand for the influx of new debt, yields—which are negatively correlated with bond prices—would need to increase from their current levels, they argue. As these fears grew in October, they contributed to Treasury prices falling to 16-year lows.
There has been a slight early-year selloff in Treasuries thus far, with the benchmark 10-year Treasury’s yield rising 16 basis points from its December lows. According to data from the Commodity Futures Trading Commission, net bearish bets on certain long-term Treasury maturities in the futures market have increased to their highest level since October.
Fed Upon The Reduction?
The Federal Reserve’s return to the Treasury bond market as a buyer may allay some of these concerns and even help to restrict the rise in long-term rates.
Through quantitative tightening, the Fed has decreased its balance sheet by almost $1 trillion since June 2022. This is a reversal of the large-scale central bank bond purchases made to stabilize markets after the coronavirus struck in 2020. However, a few Fed representatives have stated that the bank ought to think about stopping and slowing down the reduction of its bond holdings.
An earlier-than-expected halt to quantitative tightening could enhance the supply-demand balance in the Treasury market since fewer government bonds would be sold to the private sector, according to JPMorgan analysts last week.