Head of Fixed Income Strategy
Although the Federal Reserve attempted to deliver a balanced message by announcing the slowdown of Quantitative Tightening (QT) starting in June and rejecting the likelihood of imminent rate cuts, the overall tone was perceived as dovish by markets. This perception stems from the decision to lower the monthly QT cap to $25 billion, rather than by $30 billion as suggested by some policymakers.
While a $30 billion cap would have sufficed to retain T-bills on the Fed’s balance sheet, the reduction of the QT cap to $25 billion indicates a desire to retain a substantial portion of coupon bonds. With a $60 billion QT monthly cap, the Fed would have retained only $53 billion in coupon-bearing US Treasuries within a year. However, with the $25 billion cap, the Fed can retain approximately $300 billion in coupon-bearing US Treasuries, roughly 25% more than with the $30 billion cap. This move is beneficial for duration as it alleviates pressure on the longer end of the yield curve.
Another reason the Fed's message appears dovish is Powell's complete dismissal of rate hikes, suggesting the next move will likely be a cut, albeit possibly delayed due to persistent inflation and a strong job market. Powell stated, "So far this year, the data have not given us that greater confidence. In particular, and as I noted earlier, readings on inflation have come in above expectations. It is likely that gaining such greater confidence will take longer than previously expected," and "We are prepared to maintain the current target range for the federal funds rate for as long as appropriate."
While the Fed will have Q2 2024 data by July's FOMC meeting, which will occur shortly after QT tapering began, the Fed may want to wait until November to assess the economic impact of a slower QT before cutting rates. However, it's also possible that if inflation fails to trend towards 2% and the job market remains stable, the Fed may not cut rates throughout the entire year.
Following the Federal Reserve meeting, it's impossible not to ponder whether the Fed is effectively monetizing US debt. The timing of the QT slowdown announcement, coinciding with the US Treasury's plans for increased issuance of coupon notes and bonds, raises questions. While reducing the volume of coupon-bearing securities exiting the Fed's balance sheet eases pressure on the long end of the yield curve and assists markets in absorbing the influx of Treasuries, it's important to note the inflationary implications of debt monetization.
Despite the initial market reaction post-FOMC, bond investors may reassess the fair value of securities, potentially demanding a higher inflation premium. Currently, this premium is elevated, a rarity seen only eight times since 1980. As the inflation premium rises, investors seek greater compensation for holding US Treasuries amid heightened inflation risks.
The short end of the yield curve is expected to hover around 5% until clarity emerges regarding potential interest rate cuts. Consequently, the 2-year yield is projected to fluctuate between 4.75% and 5%. Any discussions of a possible rate hike by policymakers could propel yields above 5%, stabilizing them in the 5% to 5.25% range.
While the short end remains anchored, long-term yields may continue to climb due to several factors:
Consequently, the long end of the yield curve remains susceptible to higher yields. A scenario where the 10-year yield reaches 5% before quarter-end cannot be ruled out.
30-Apr FOMC preview: challenging the March dot plot.
29-Apr Bond Markets: the week ahead
25-Apr A tactical guide to the upcoming quarterly refunding announcement for bond and stock markets
22-Apr Analyzing market impacts: insights into the upcoming 5-year and 7-year US Treasury auctions.
18-Apr Italian BTPs are more attractive than German Schatz in today's macroeconomic context
16-Apr QT Tapering Looms Despite Macroeconomic Conditions: Fear of Liquidity Squeeze Drives Policy
08-Apr ECB preview: data-driven until June, Fed-dependent thereafter.
03-Apr Fixed income: Keep calm, seize the moment.
21-Mar FOMC bond takeaway: beware of ultra-long duration.
18-Mar Bank of England Preview: slight dovish shift in the MPC amid disinflationary trends.
18-Mar FOMC Preview: dot plot and quantitative tightening in focus.
12-Mar US Treasury auctions on the back of the US CPI might offer critical insights to investors.
07-Mar The Debt Management Office's Gilts Sales Matter More Than The Spring Budget.
05-Mar "Quantitative Tightening" or "Operation Twist" is coming up. What are the implications for bonds?
01-Mar The bond weekly wrap: slower than expected disinflation creates a floor for bond yields.
29-Feb ECB preview: European sovereign bond yields are likely to remain rangebound until the first rate cut.
27-Feb Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment.
23-Feb Two-year US Treasury notes offer an appealing entry point.
21-Feb Four reasons why the ECB keeps calm and cuts later.
14 Feb Higher CPI shows that rates volatility will remain elevated.
12 Feb Ultra-long sovereign issuance draws buy-the-dip demand but stakes are high.
06 Feb Technical Update - US 10-year Treasury yields resuming uptrend? US Treasury and Euro Bund futures testing key supports
05 Feb The upcoming 30-year US Treasury auction might rattle markets
30 Jan BOE preview: BoE hold unlikely to last as inflation plummets
29 Jan FOMC preview: the Fed might be on hold, but easing is inevitable.
26 Jan The ECB holds rates: is the bond rally sustainable?
18 Jan The most infamous bond trade: the Austria century bond.
16 Jan European sovereigns: inflation, stagnation and the bumpy road to rate cuts in 2024.
10 Jan US Treasuries: where do we go from here?
09 Jan Quarterly Outlook: bonds on everybody’s lips.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
