(Bloomberg) -- The world's biggest bond market is reaching a turning point, with US Treasuries wiping out their 2024 losses as traders start to embrace the idea of three interest-rate cuts this year.
Optimism tied to an ebb in inflation was on full display this week in US government debt, with yields across the curve slumping as the data was seen supporting the case for lower borrowing costs as soon as September. Two-year Treasury yields — more sensitive than longer maturities to Federal Reserve monetary policy — are down 12 basis points this week to 4.48%, the lowest since March.
"All signs point to the Fed starting rate cuts in September," said Sinead Colton Grant, chief investment officer at BNY Mellon Wealth Management. "You are seeing a market participant reaction to CPI on the back of a softer June labor market report" and Fed Chair Jerome Powell's recent testimony to US lawmakers.
Powell reiterated this week in Washington that rate cuts are contingent on ebbing price pressures and that policymakers would be closely watching for that. On Thursday, June consumer price index data showed a decline in overall prices and fueled a rally in the bond market.
While US producer prices climbed in June by slightly more than forecast in data released on Friday, market participants focused more on a drop in consumer sentiment. Yields were broadly lower.
The moves this week have helped the Bloomberg US Treasury Index to climb 0.3% this year, as of Thursday's close, erasing a year-to-date loss of as much as 3.4% in April.
"Clearly a lot of people missed the yield highs at 4.75%, and there is a bit more FOMO — but also more conviction that the cycle is moving in the direction of lower yields," said John Madziyire, senior portfolio manager at Vanguard. "Now that the Fed is in play, you want to extend longer out the curve."
Interest-rate swaps showed traders have all but fully priced in a quarter-point rate cut by the September meeting and are targeting more than two reductions this year.
Some have begun to contemplate the potential for a half-percentage-point cut in September, buying October federal funds futures contracts in large size at prices that only make sense if more people buy into the idea that the Fed could begin its first easing cycle in years with a supersized move.
What Bloomberg strategists say...
"A drip drip of weak economic data and yesterday's soft CPI will make it hard for Treasury bears to gain sway. But the steepener is still the trade to watch."
— Edward Harrison, "The Everything Risk" newsletter
Traders are now looking ahead to readings of the The Fed's preferred measure of underlying inflation — the so-called core personal consumption expenditures price index, which strips out volatile food and energy items — and more information on the job market.
"The single most important market item in the coming months will be the performance of the labor market," said John Brady, managing director at RJ O'Brien. "The pace of slowing in the labor market — with the unemployment rate already at 4.1% — is going to dictate policy and will define the 'soft-landing' versus 'hard-landing' price action in our markets."
--With assistance from Edward Bolingbroke.
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