How long will high rates last? Bond Markets Say Maybe Forever

(Bloomberg) — As optimism grows among investors that a rally in U.S. Treasuries is imminent, a key bond market indicator is sending a worrying sign to anyone considering investing there.

Most read on Bloomberg

First, the good news. With mid-year 2024 in sight, Treasuries are poised to erase their losses for the year as signs finally emerge that inflation and the job market are both on the decline. actually slow down. Traders are now betting that could be enough for the Federal Reserve to start cutting interest rates as soon as September.

But there is a growing view in markets that the economy’s so-called neutral rate – a theoretical level of borrowing costs that neither boosts nor slows growth – is much higher than that of policymakers, which could limit the central bank’s ability to cut and thus create a headwind for bonds. are currently being planned.

“What is important is that when the economy inevitably slows down, there will be fewer rate cuts and interest rates over the next ten years could be higher than they were over of the last ten years,” said Troy Ludtka, senior U.S. economist at SMBC Nikko. Securities America, Inc.

Futures contracts referencing the five-year interest rate over the next five years — a proxy for the market’s view of where U.S. rates might move — are stuck at 3.6%. Although this figure is down from last year’s high of 4.5%, it is still more than a percentage higher than the average of the last decade and higher than the Fed’s own estimate of 2.75%.

This is important because it means the market is pricing in a much higher yield floor. The practical implication is that there are potential limits to the scope of obligations. That should worry investors preparing for the type of epic bond rally that saved them late last year.

For now, investor sentiment is increasingly optimistic. A Bloomberg gauge of Treasury yields was down just 0.3% in 2024 on Friday, after losing as much as 3.4% for the year at its lowest point. Benchmark yields are down about half a percentage point from their annual peak in April.

In recent sessions, traders have stocked up on contrarian bets that could benefit from greater chances that the Fed will cut interest rates as early as July and futures demand that a rally in the bond market is booming.

But if the market is correct that the neutral rate – which cannot be observed in real time because it is subject to too many forces – has risen permanently, then the Fed’s current benchmark rate of above 5% is perhaps not as restrictive as we think. Indeed, a Bloomberg gauge suggests that financial conditions are relatively loose.

“We’ve only seen a fairly gradual slowdown in economic growth, which suggests the neutral rate is significantly higher,” said Bob Elliott, CEO and chief investment officer at Unlimited Funds Inc. Given economic conditions current and limited risk premiums, in…

Read Complete News ➤

Leave a Reply

Your email address will not be published. Required fields are marked *

nineteen + 12 =