Skyrocketing bond moves bring a 4% yield into play to attract investors

(Bloomberg) – Bond traders are bracing for another tumultuous week in which key jobs data could push 10-year Treasury yields towards 4%, a level that market watchers believe is luring investors into Treasuries.

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US interest rates rose within striking distance on Thursday, climbing as high as 3.89% after an upward revision to US first-quarter economic growth and a drop in initial jobless claims prompted the biggest day for government bonds in more than three months. Yields on most maturities this year approached their highest levels yet, while bets that the Federal Reserve could cut interest rates this year fizzled.

A plethora of events over the next week could lead to fresh sell-offs and push yields to 4%, not the least of which is the release of the first major economic reports for June – including key jobs data – and the minutes of the Federal Reserve's last meeting. But the question for bond investors now is whether yields in the 4% range are attractive and provide enough compensation for the risk that the central bank cannot get inflation under control.

The 4 percent level for 10-year yields will create “a wave of demand” from investors, said Zachary Griffiths, senior fixed income strategist at CreditSights Inc.

The research firm sees a 50/50 chance of another Fed rate hike at the next monetary policy meeting on July 26 — and cuts by a quarter point at each meeting in 2024. Even if that scenario doesn't materialize and the Fed takes a more aggressive stance, Griffiths goes expect this to limit the sell-off in longer-dated government bonds.

On the other hand, rate strategists at JPMorgan Chase & Co. gave up their bullish Treasury forecast this week in anticipation of further cheapening, and Bill Dudley – a former New York Federal Reserve Bank President – said 4.5% was “a conservative estimate” . ” for the peak of 10-year returns.

It all depends on how many rate hikes the Fed needs to bring inflation under control and whether it can do so without plunging the economy into a painful recession.

The Fed left interest rates unchanged at 5% to 5.25% on June 14 after ten consecutive hikes, in line with most forecasters' expectations. The revised quarterly forecasts for the economy and monetary policy released that day showed that officials expect to hike interest rates twice more by the end of the year.

Minutes from the June meeting are due to be released on Wednesday and could clarify the rationale for the pause, which Fed Chair Jerome Powell says is appropriate to assess how hiked interest rates are affecting the economy. There were signs of trouble in March when several regional banks failed due to losses on their securities holdings related to higher borrowing costs. However, other indicators – such as those focusing on employment – ​​remain robust.

“The market is very focused on labor markets as what needs to weaken for the Fed to finally be really ready for the cycle,” said Dominic Konstam, head of macro strategy at Mizuho Securities. Central banks “are clearly concerned that policies are not restrictive enough to contain inflation.”

Still, expectations that the Fed's tightening cycle will lay the groundwork for lower inflation helped push long-dated government bond yields relative to shorter-dated bonds to historic lows this week. The two-year yield beat the 10-year yield by nearly 107 basis points, just 4 basis points short of the widest gap in decades.

Breakeven inflation rates for inflation-linked government bonds – the average annual inflation rates required to reach the higher yields of regular government bonds – have almost returned to the sub-2% level prevailing through 2021. Five- and 10-year breakeven rates are around 2.2%, compared to the CPI's year-over-year rate of 4% in May.

And JPMorgan's weekly Treasury customer survey this week returned the highest level of positive sentiment in more than a decade.

“The tightening cycle will keep up with the economy,” said Laird Landmann, co-director of fixed income at TCW Group Inc that will result in a slowdown in the US economy or a hard landing.”

For institutional investors such as foundations and pension funds, the yields on government bonds are currently attractive, said Landmann.

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