Two-year US Treasury notes offer an appealing entry point.

Two-year US Treasury notes offer an appealing entry point.

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Sticky consumer and producer prices, a resilient job market, and solid PMI readings are not putting pressure on the Federal Reserve to begin cutting rates. At the same time, the FOMC minutes indicate that the tapering of the Quantitative Tightening is imminent, and it will be discussed in March, ahead of the US Treasury issuing pandemic-like levels of coupon notes and bonds in the second quarter of the year. The recent rise in yields in the front part of the yield curve offers an appealing entry point for investors, as current valuations match the Dot Plot with expectations of three interest rate cuts for this year. However, we remain cautious and see the risk of a bear-steepening of the yield curve triggered by sticky inflation and the issuance of pandemic-like amounts of notes and bonds.


The FOMC minutes show that the tapering of Quantitative Tightening is imminent.

We have learned from the FOMC minutes that policymakers are willing to hold current rates for longer but are starting to worry about systemic liquidity. The minutes say, "In light of ongoing reductions in usage of the ON RRP facility, many participants suggested that it would be appropriate to begin in-depth discussions of balance sheet issues at the Committee's next meeting to guide an eventual decision to slow the pace of runoff. Some participants remarked that, given the uncertainty surrounding estimates of the ample reserve level, slowing the runoff pace could help smooth the transition to that level of reserves or could allow the Committee to continue balance sheet runoff for longer.”

To be clear, bank reserves are ample and exceed $4 trillion. Yet, once that Overnight Reverse Repurchase (ON RRP) facility, which currently amounts to a little over $500 billion, is drained, US reserve balances with the Federal Reserve banks will begin to be depleted. That's when liquidity might start to become stretched, warranting a slower pace of runoff to avoid a liquidity event such as the one in 2019.

An announcement regarding Quantitative Tightening (QT) is likely to come as soon as March because the US Treasury is preparing to issue pandemic-like levels of coupon bonds. If the Federal Reserve doesn't slow down QT, further pressure will be applied on US Treasuries, causing further tightening of financial conditions. Remember that the Bank Term Funding Program (BTFP) is ending in March, and bank liquidity is being withdrawn.

Based on the latest Treasury Borrowing Advisory Committee Advisory (TBAC) recommendations, coupon issuance might rise by $33 billion in Q2. The pace of balance sheet runoff is currently capped at $60 billion a month. Therefore, it’s enough for the Fed to taper QT by $11bn a month to not add pressure in bond markets.

There is no love for duration.

The recent 20-year US Treasury and 30-year TIPS auctions show weak demand for ultra-long maturities. The 20-year US Treasury auction saw a significant drop in indirect bidders to 59.1%, the lowest since May 2021. The bid-to-cover price has also dropped to the lowest since August 2022, resulting in a 3.3bps tail. The day after, the 30-year TIPS auction also tailed by 2.5bp despite paying 2.2% in yield, the highest since 2010. Demand for TIPS was much more solid than the 20-year bonds, showing that investors are still buying inflation protection but demand higher returns in light of uncertainties concerning price pressures.

With the US Treasury looking to sell $1 trillion coupon notes and bonds in the second quarter of the year, we expect ultra-long US Treasury auctions to be the cause of volatility, contributing to a rise in yields in the long part of the yield curve. We remain cautious and don't see scope to add duration beyond the ten years as explained here.

Expectations for interest rate cuts are now matching the Dot Plot.

Sticky consumer and producer prices, a resilient job market, and solid PMI readings have provoked a bear-flattening of the US yield curve. Two-year US Treasury yields (US91282CJV46) rose from 4.11% in January to 4.73% today. Such a move offers an appealing entry point for investors, as current valuations match the Fed dot plot expectations of three interest rate cuts for this year. For two-year US Treasury yields to rise further, inflation must remain sticky in the high 2% or rebound, forcing the Fed to push back on rate cuts. Even if that happens, the 2-year US Treasury offers an appealing risk-reward ratio even when assuming a short-term holding period. Assuming a three-month holding period, yields need to rise by more than 100bps to provide a loss. If the holding period increases to six months, yields need to rise to 6.75% before giving a negative total return. For yields to rise that much in such a short time frame, inflation needs to rebound substantially, forcing the Federal Reserve to hike the Fed Fund rate four more times in only six months, which, at the moment, looks extremely unlikely to happen.

Source: Bloomberg.

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, 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. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such 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.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

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

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.