(Bloomberg) -- Treasuries held onto their recent gains as traders weighed signs of a resilient US economy against calls for quicker interest-rate cuts from the Federal Reserve.
US government debt remained stronger across the maturity spectrum on Thursday, though it pared the day's early gains after data showing growth accelerated by more than forecast in the second quarter. That reading reinforced bets that US policymakers will wait until September to kick off their monetary easing cycle.
Wagers on aggressive easing by the Fed had been rising in recent days amid debate over whether the central bank should act when it meets next week. Former New York Fed President William Dudley said Wednesday that US policymakers should reduce rates at that gathering. And Mohamed El-Erian warned said Thursday that too long a delay on cuts could prove a "policy mistake." Both were writing as Bloomberg Opinion columnists.
Investors saw Thursday's data giving policymakers a reason to hold off on reductions until September. Swaps traders are pricing in about 64 basis points worth of reductions in the US this year.
"I don't think it's urgent to reactively cut rates in a very aggressive fashion," said Gabriela Santos, chief market strategist for the Americas at JPMorgan Asset Management, on Bloomberg Television. "It's important to normalize interest rates sooner rather than later. Sooner I don't think is next week, but September is still very much on the table even after this morning's data."
Discussions surrounding the potential for more-aggressive easing caused the US yield curve to adjust sharply on Wednesday, as the drop in policy-sensitive two-year yields left them higher than 10-year yields by the smallest margin since October 2023.
On Thursday, that steepening move stalled after US gross domestic product increased at a 2.8% annualized rate, well above the consensus forecast. Two-year Treasury yields hovered near 4.45%, rebounding from the day's low of 4.34%. Benchmark 10-year yields were down three basis points after earlier dropping nearly 10.
Traders are looking ahead to the Friday personal consumption expenditures data — the central bank's preferred underlying inflation measure — which is expected to show softening price pressures.
Yields remained lower after the market digested a $44 billion auction of seven-year notes, the last of a trio of sales this week. Demand was good for seven-year securities, compared to mediocre appetite for Wednesday's five-year offering and record-setting demand for Tuesday's auction of two-year Treasuries.
Bonds were stronger in European markets, too, with momentum in Treasuries helping to boost bunds and gilts — and prompting investors to price more easing this year by both the European Central Bank and Bank of England.
"The bond market is driven by the rising expectation of Fed cuts in the September meeting, given the stock market rout and weaker US data as of late," said Janet Mui, head of market analysis at RBC Brewin Dolphin. "Financial conditions have tightened in recent weeks so that argues for some policy easing to be brought forward."
Easing Wagers
While US money markets still suggest a move by the Fed this month is highly unlikely, traders are pricing about 25 basis points of easing by September, suggesting a small chance of a super-sized cut.
Meanwhile, traders see a cut next week in the UK as a coin-toss, and expect 55 basis points of reductions by the European Central Bank this year.
The move in US Treasuries over the past few days boosted a revival of so-called steepeners — which wager on the difference between yields on short- and long-dated debt — and have been a favored trade of investors who expect Donald Trump to win the presidential election in November.
The US bond curve has been inverted for years as the Fed keeps monetary conditions tight, meaning short-term Treasuries yield more than long-term ones. That's in contrast to conventional thinking about debt, which would see longer-maturity securities pay a premium to compensate investors for the additional risk embedded within their longevity.
"Inverted curves don't paint a picture of a typical bond market, and so we do think that steepeners are where we would prefer to be at this point," said Eva Sun-Wai, a global government bond fund manager at M&G Investments. "Regardless of your view on politics or growth going forward, I think it's fair to say there needs to be more term premium priced at the long-end."
Debate over US easing coincided with a rate cut in China and further evidence that Europe's recovery is struggling.
The People's Bank of China unexpectedly lowered the cost of its one-year policy loans by the most since April 2020 earlier Thursday, acting days after cutting a key short-term rate in a sign of greater support for the slowing economy.
Meanwhile in Germany — the region's biggest economy — the business outlook unexpectedly darkened just a day after data showed a shock plunge of the S&P Global Purchasing Managers' Index. French business confidence posted a similar slump, reaching levels not seen since the Covid-19 pandemic as companies reckoned with the turbulence of snap elections.
Political developments and geopolitical tensions mean safe assets like sovereign debt are primed to perform, said Antonio Cavarero, head of investments at Generali Asset Management.
--With assistance from Alice Atkins and Anchalee Worrachate.
(Updates rates throughout with closing prices.)
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