The convergence of interest rate cut expectations is rewriting the narrative of global capital markets.
Recently, due to the impact of U.S. economic fundamentals such as inflation and employment that exceeded expectations, market expectations for the Federal Reserve to cut interest rates within the year have declined. The “anchor of global asset pricing” has made waves again. The 10-year U.S. Treasury yield recently broke through the 4.5% mark and remains above this point.
Some market participants are worried that the “nightmare” of 10-year U.S. bond yields pointing to 5% may strike again. Analysts believe that the current asset prices are more reflected in the correction of front-running transactions in anticipation of interest rate cuts. Looking ahead, interest rate cut expectations may continue to swing driven by data and geopolitics, affecting the trend of U.S. bond yields.
Multi-maturity U.S. Treasury yields rise
The rapid rise in U.S. bond yields has once again attracted market attention.
On April 10, local time, as the U.S. Consumer Price Index (CPI) in March exceeded expectations across the board, the market was worried about the prospect of “reflation” in the United States. Expectations for an interest rate cut in June plummeted, and multi-maturity U.S. bond yields rose.
After breaking through the 4.5% mark the previous day, the 10-year U.S. bond yield continued to rise on April 11, hitting an intraday high of 4.597%; the 2-year U.S. bond yield once broke through the 5% mark during the session, which was the highest level on April 11 last year. For the first time in months, the yields on 1-year and shorter-term U.S. Treasury bonds remain at high interest rates starting with the prefix “5”.
“U.S. inflation is once again on the rise, sending ripples of uncertainty through financial markets and casting doubt on the Fed’s interest rate plans.” Bob Schwartz, senior U.S. economist at Oxford Economics Schwartz said in an email to a reporter from Shanghai Securities News.
At the same time, long-term and short-term U.S. bond interest rates have significantly inverted. As of April 11, 2024, the maturity yields of 3-month, 2-year, and 10-year U.S. Treasury bonds are 5.45%, 4.93%, and 4.56% respectively. Long-term interest rates are significantly lower than short-term interest rates.
According to industry insiders, long-term interest rates will be higher than short-term interest rates under normal circumstances due to higher risk premiums. Based on historical experience, an inversion in U.S. bond interest rates often indicates a possible economic recession.
“The current situation is different. At this stage, mainstream market views rarely believe that the U.S. economy will experience a recession in the short term. The main reason for the inverted term spread is that the market is trading in advance for subsequent interest rate cuts by the Federal Reserve.” Yan, chief economist at Huafu Securities Xiang said that long-end interest rates are significantly lower than short-end interest rates, reflecting that long-end bond asset prices are currently overvalued. If subsequent policy interest rate cuts are less than expected, long-end bond asset prices are at risk of adjustment (that is, interest rates rise).
Interest rate cut expectations revised again
As expectations for the Federal Reserve to cut interest rates continue to cool, traders are beginning to prepare for no interest rate cuts during the year, and the “nightmare” of 10-year U.S. Treasury yields pointing to 5% has struck again.
On the same day that the U.S. CPI was released in March, the U.S. Treasury Department auctioned $39 billion in 10-year Treasury bonds, and the auction results were quite dismal. The pre-issuance interest rate for this 10-year U.S. bond auction was 4.529%, and the final bid interest rate was 4.560%. The tail spread was as high as 3.1 basis points, which is the third highest tail spread in history.
All of the above will inevitably remind the market of the “U.S. debt crisis” in the third quarter of last year. At that time, also disturbed by factors such as the fallback in inflation and the dismal U.S. debt auction, the 10-year U.S. Treasury yield rose strongly above 5%, soaring interest rates suppressed risk appetite, and global assets were “turbulent.”
However, according to analysts’ observations, the current market narrative is still different from that of then. “The trend in U.S. bond interest rates in the third quarter of last year was more driven by the increase in term premium, which was due to the large-scale bond issuance by the U.S. Treasury that disrupted the balance of supply and demand. At this stage, it may be more reflected in pricing adjustments to inflation expectations and economic fundamentals. , and the previously anticipated interest rate cuts are constantly being revised,” a macro researcher told reporters.
Yan Xiang believes that according to traditional classic indicators, the current prices of various overseas assets including U.S. bonds, U.S. stocks, gold, etc. are generally overvalued. The operating logic behind the above-mentioned asset prices is largely a front-running trade in anticipation of an interest rate cut by the Federal Reserve. A large number of historical studies have shown that after the Federal Reserve begins to cut interest rates, the prices of stocks, bonds, and gold will rise.
How will the trend of U.S. bond yields be interpreted?
CPI data that has exceeded expectations for three consecutive months, and “first drop” timing expectations are constantly being postponed… As the data continues to be updated, more and more financial institutions have started the “tear up reports and change forecasts” mode.
For example, the UBS Wealth Management Investment Chief Office (CIO) expressed an institutional view that based on the latest data, the current baseline scenario is that the Federal Reserve will start cutting interest rates in September this year (previously June), and cut interest rates by 50 basis points throughout the year (previously 75 basis points). basis points). Economists at Goldman Sachs pushed back their forecast for a rate cut from June to July.
Analysts believe that looking ahead to the market outlook, interest rate cut expectations may continue to swing driven by data and geopolitics. Against this backdrop, how will U.S. bond yields behave?
CICC believes that, generally speaking, it is expected that U.S. bond interest rates may rise further in the short term, and may gradually fall again starting in the third quarter, provided that there is a relatively obvious adjustment in the stock market. Since the supply of U.S. Treasury bonds is still high this year, bond investors alone may not be able to lower interest rates. Therefore, stock investors may also need help from increasing their holdings. The prerequisite for increasing their holdings may be that the decline in U.S. and European stock markets triggers a shift in asset allocation demand.
Zhou Hao, chief economist of Guotai Junan International, wrote in the report that geopolitical risks and inflationary pressures together began to suppress global risk aversion. It is expected that short-term U.S. bond interest rates will remain at a high level due to factors such as inflation and delays in interest rate cuts, while long-term U.S. bond interest rates may rise to a certain extent due to risk aversion and the suppression of long-term growth expectations by rising inflation. “suppressed”.
