Althea Photoshoot 26054S Althea Photoshoot 26054S Althea Photoshoot 26054S

US Treasuries: where do we go from here?

Bonds
Picture of Althea Spinozzi
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  The new year is going to be all about yield curve normalization. Although the road to a steeper yield curve will be bumpy due to geopolitical and monetary policy uncertainties, sovereign bonds remain compelling. A deflationary environment builds the case for a longer bond duration.


The new year is starting with one certainty: the normalization of the yield curve is underway.

The reason is simple: central banks' focus turns from inflation to growth. That means that as inflation reverts to its mean, central banks will claim victory over inflation and will be more concerned about a deteriorating economy. That will call for interest rate cuts, precisely as the Federal Reserve's December dot plot shows. Therefore, it is safe to expect font-end rates to adjust lower, resulting in a steeper curve.

The big question, however, is what will happen to the longer part of the yield curve as central banks cut rates. When answering this question, it’s impossible not to enter into a heated debate regarding some sort of landing:

  1. A “soft landing”: such a scenario implies that inflation reverts to its mean without a significant deceleration of the economy. In this case, the yield curve will bull steepen, but without a recession, the long part of the yield curve will remain around current levels or even move slightly higher.
  2. A “hard landing”: such a scenario implies a deep recession is upon us. That means the Federal Reserve might need to cut rates deeply and quickly. That would result in a steeper curve, with 10-year yields dropping sharply below 4%.
  3. A “’70s landing”: the fight against inflation is not over, and as geopolitical tensions intensify, inflation rebounds, resulting in a new inflation wave. Yet the economy stagnates, resulting in a flatter yield curve.

Although it's impossible to know which kind of landing we are headed towards, it's essential to recognize that the Fed can stimulate the economy through various policies beyond interest rate cuts, such as a slowdown or the early end of the Quantitative Tightening program (QT).

QT is a powerful tool because it can be a substitute for interest rate cuts. Therefore, if a “hard landing" doesn't materialize, bond futures must price out some of the six rate cuts that are baked in for this year.

Moreover, we must remember that the US Treasuries is poised to continue issuing large amounts of bonds and notes in the upcoming months, putting upward pressure on rates.

That means that if a recession is not around the corner and the economy continues to prove resilient, 10-year yields are more likely to move higher than lower in the upcoming weeks. That's probably why Bill Gross, in a recent tweet, says that "UST 10 yr at 4% is overvalued while 10 year TIP at 1.80 is the better choice. If you need to buy bonds. I don’t.” When looking at the market's expectations for interest rate cuts, 10-year yields at 4% do not make sense because investors expect rates to decrease to 3.5% in the next ten years. Considering that 10-year US Treasury offers between 100bps to 150bps over the Fed Fund rate from 2000 until today, their fair value should be around 4.5% to 5%. Yet, market expectations can change abruptly, especially during a downturn.

Therefore, we'll likely see ten-year US Treasury yields rising slightly and trade rangebound for some time until the macroeconomic backdrop becomes clearer.

Currently, 10-year yields us10tyields d 0501us10tyields d 0501are trading slightly above 4%. If they break above 4.1%, they might find a new trading range between 4.1%- 4.3% (see Kim Cramer Larsson's technical analysis piece).

10_01_2024_AS1
Ten-year US Treasury yields. Source: Saxo Platform.

Sovereign bonds remain attractive for long-term investors.

Even if yields rise in the medium term, sovereign bonds remain an attractive investment for buy-to-hold investors. Extending a portfolio duration is also compelling in light of deflationary trends and central bank's plans to cut rates.

Benchmark bonds issued during the last Treasury quarterly refunding offer a coupon that creates a buffer against a possible drop in price. The ten-year tenor looks particularly compelling. Assuming a one-year holding period, if yields rise by 100bps, the loss that one would expect is a little above 2%. As we learned last year, 5% is a strong resistance level for 10-year US Treasuries. If yields could not break above this level when it was uncertain whether the Federal Reserve was done with its interest rate hiking cycle, it is hard to envision they would even rise around this level now that central banks are preparing to cut rates on both sides of the Atlantic.

10_01_2024_AS2

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • 350x200 peter

    Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • 350x200 althea

    Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • 350x200 peter

    Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • 350x200 charu (1)

    FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • 350x200 ole

    Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.