Global Bond Rally Hits $125B US Treasury Test Amid Rate Cut Bets

Key Takeaway

• The global bond rally, spurred by Powell's dovish remarks and soft job data, faces a $125 billion supply test with this week's US Treasury auctions.
• Investors' appetite for Treasuries after recent yield declines to be tested; swaps now price in up to two Fed rate cuts by year-end.
• Recent allocations show increased investor interest in fixed income, particularly Treasuries, amid expectations of stable high US rates.

Cooling Labor Market Fuels Treasury Rally

The recent US jobs report showcased unexpected softness in job and wage gains, hinting at a cooling labor market. This development, alongside Federal Reserve Chair Jerome Powell's less hawkish remarks, has ignited a rally in US Treasuries, particularly in Fed-sensitive two-year notes. Despite these positive developments, the persistent issue of sticky inflation poses a significant challenge to the central bank's ability to significantly alter its course. This situation potentially keeps bond yields within their recent ranges, limiting the impact of anticipated rate cuts.

Treasury Auctions: A Litmus Test for Investor Sentiment

The Treasury is set to auction $125 billion in securities this week, including $67 billion in 10- and 30-year Treasury securities and $58 billion of three-year notes. These auctions will test investor demand for longer-dated debt amid growing skepticism. Some investors have expressed caution towards these securities due to the uncertain inflation outlook and the government's fiscal policies. Mark Lindbloom of Western Asset Management, overseeing about $385 billion, prefers shorter-term US securities, indicating a cautious market sentiment towards longer-term debt.

Market Adjusts to Rate Cut Expectations

Investors have adjusted their expectations to nearly two full rate cuts this year, a significant shift from earlier predictions. This adjustment reflects growing speculation that the Fed may ease its policy stance sooner than previously anticipated, based on recent economic data. However, the outlook for longer-term bonds, such as the 10- and 30-year Treasuries, remains less optimistic. Concerns over sustained inflation and potential increases in auction sizes have dampened enthusiasm for these securities. George Catrambone of DWS Americas and Jennifer Karpinski of Jennison Associates both highlighted the challenges facing the long end of the curve, suggesting a preference for shorter-duration Treasuries.

Street Views

• ING Bank NV rate strategists including Benjamin Schroeder (Neutral on US Treasuries):

  "Yields have come down considerably over the past week so $125 billion of issuance should provide a good health check of current levels. In the short run, the trigger for higher yields can still come from the US."

• Michael Metcalfe, State Street Global Markets (Cautiously Optimistic on fixed income):

  "If US interest rates really are going to be high and stable for now, investors may begin to re-assess their significant underweight in fixed income and look to have begun doing this in April."