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...
Bond Markets: the week ahead
Althea Spinozzi
Head of Fixed Income Strategy
Summary:
- Despite first-quarter GDP growth falling short of expectations, bond markets focus on the persistent core PCE, anticipating a patient stance from the Federal Reserve on rate cuts.
- The Quarterly Refunding Announcement (QRA) this week holds significance, with expectations of lower borrowing needs from the Treasury. However, indications of continued coupon issuance growth, exceeding $1 trillion quarterly, may constrain upside for US Treasuries.
- The FOMC meeting revolves around expectations of rate cuts and QT deceleration amidst inflation concerns. Anticipated intensification of QT tapering discussions reflects policymakers' growing apprehension about the ample reserves in the system, despite inflation showing resilience.
- While a dovish FOMC meeting could trigger a yield decrease, the prevailing upward trajectory of 10-year yields persists, suggesting a potential breach above 4.7% in the weeks ahead.
Key takeaways from last week
In recent weeks, the bond market has been conveying a critical message: inflation reigns supreme over all other economic indicators.
US Treasury yields have surged across the board, reaching levels not seen since November last year. The rationale behind this surge is straightforward: Inflation appears entrenched well above the Federal Reserve's 2% target, hovering around 3% with indications of a potential rebound. Consequently, the Fed may be compelled to maintain interest rates at their current levels for an extended period or, if a second wave of inflation materializes, resume interest rate hikes. Consequently, fixed income investors are demanding a higher premium to hold onto fixed-income securities. This was confirmed at this week's 5- and 7-year US Treasury auctions, which witnessed solid demand, but investors demanded higher yields. This indicates that US Treasuries are still considered a viable diversification tool in one's portfolio, nevertheless at the right price.
Currently standing at 4.6%, the 10-year US Treasury yield reflects the market's expectations of persistent inflation above the Fed's target and sustained economic growth.
Despite a weaker-than-anticipated GDP print for the first quarter, which saw real growth at 1.6% compared to the expected 2.4%, investors have focused on the first quarter's annualized core PCE, which rose to 3.7% versus an expected 3.4%.
Economists were swift to downplay the lower GDP figure, suggesting that once the cyclical components (net exports and inventories) were removed, the annualized GDP for the quarter would still hover around 2.8%. This narrative dispels the notion of an economy teetering on the brink of collapse, painting a picture of a more resilient economic landscape.
The heart of the issue lies within core PCE. Not only does it appear to be stabilizing, but the three- and six-month annualized figures suggest a potential rebound in core PCE, mirroring the intensity of the upward trend witnessed in 2021.
Critical bond market events unfolding this week
The week ahead holds significant events for bond markets, with the FOMC meeting and the Quarterly Refunding Announcement (QRA), both occurring today, taking the spotlight. The QRA will reveal the upcoming coupon sales size for May 1st. Anticipation is for bullish movements in risky assets, given the expected decrease in gross Treasury issuance from its peak of over $7.2%. Even if coupon issuance sees a bump from the previous quarter, markets are likely to interpret the drop in gross supply positively, providing some relief. If you want to learn more about it click here.
During the FOMC meeting, attention will pivot towards signals of potential delays in interest rate cuts and a deceleration in Quantitative Tightening (QT). The total amount of reserves, comprising RRP bids plus bank reserves at the Federal Reserve, has dipped to $3.7 trillion, for the first time since March 2021. Based on preliminary 1Q US GDP figures, the ample reserve buffer ranges between $2.8 trillion to $3.4 trillion, with just a $390 billion gap from the upper bound. Consequently, discussions around QT tapering are expected to intensify, despite recent inflation surprises trending upwards.
Key yield thresholds to keep an eye on.
The ten-year yields persist in an upward trajectory, oscillating within a range of 4.58% to 4.70% in recent weeks. A dovish stance from the Federal Reserve, coupled with reduced borrowing requirements from the US Treasury, may precipitate a decline in yields, potentially testing support at 4.38%. Should they breach this threshold, the next level of support lies at 4.5%. However, the forthcoming quarterly refunding policy statement on May 1st is expected to reveal the Treasury's intention to increase coupon issuance, underpinning the prospect of sustained higher yields in the long run.
Irrespective of the Quarterly Refunding Announcement (QRA), a hawkish Fed could sustain upward pressure on yields, potentially testing resistance at approximately 4.7%. Should yields surpass this level, the subsequent resistance level looms at 4.99%.
Two-year US Treasury yields have hovered between 4.90% and 5% over the past few weeks. Should markets rate cuts completely for the remainder of the year, yields could breach the 5% mark for the first time since November of last year. Conversely, if the Fed remains committed to its projected three rate cuts, as indicated by the Dot plot, two-year yields might retreat towards 4.75% once more.
Other recent Fixed Income articles:
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.
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