Bond Market Has Worst Week in Months With Fed Action Seen

An orderly selloff in the US government bond market continued for a fifth straight day, with the 30-year bond’s yield posting its biggest weekly increase of the year.

Driven in part by shifting expectations the Federal Reserve will cut interest rates next month and potentially pause next year, the rise in yields back toward their November highs also was fueled by weak demand for an auction of 30-year debt Thursday. The yield for that tenor reached 4.61% on Friday, about 28 basis points higher on the week. 

Shorter-maturity yields rose by smaller increments, while the the 10-year’s was up by 25 basis points to 4.40%, exceeding the three-month bill’s on Friday for the first time since 2022. 

Conviction that the Fed will drop its target for the US overnight lending rate to a range of 4.25%-4.5% on Dec. 18 moved toward certainty this week after November inflation data in line with expectations were viewed as no obstacle. That was keeping downward pressure on short-term yields, while longer maturities priced in a risk that policymakers will simultaneously signal an intention to pause cuts next year amid economic resilient and halting progress toward lower inflation.

Yields are “pricing in a Fed that is going to sit here for a little bit,” Rick Rieder, BlackRock chief investment officer for global fixed income, said on Bloomberg Television. “The economy is in a good shape. Inflation, if anything, is bending up.” The extra yield offered by long- versus short-maturity yields “is not enough at this point of time.”

Next week’s Fed meeting includes an updated summary of economic projections showing where officials see interest rates over the next three years and their estimate of the neutral rate — a theoretical level that neither stimulates or restricts the economy. In September, the projections anticipated a drop in the policy rate to 3.25%-3.5%, or four quarter-point cuts assuming one next week.

While traders continue to price in that a quarter-point rate cut next week will be followed by two more in 2025, economists at Deutsche Bank AG and BNP Paribas have predicted no Fed action in 2025. BNP Paribas expects next week’s action to be accompanied by hawkish language supporting that view. They see the 10-year Treasury yield rising to 4.65% next year.

“Ideally, you cut at this December meeting because you’re continuing your 25-basis-point cut per meeting path and leave open a strong likelihood that you’re going to pause in January,” said Jason Pride, chief of investment strategy and research at Glenmede. “Next year, they are going to be deciding between two and four cuts,” said Pride. “There is lot of the debate around the inflationary aspects of the next administration’s policies on tariffs and immigration.”

Activity in interest-rate futures this week suggested some traders see the potential for a surprise cut early next year. Open-interest data in recent days indicated that new long positions had been set in February federal funds futures, anticipating quarter-point rate cuts in both December and January. 

Two- to 30-year Treasury yields rose for a fifth-straight day Friday, with the 10-year note’s nearly reaching 4.40%, still some 10 basis points below its November highs. None of the daily moves were large by historical standards, however, and an index of Treasury market volatility declined to its lowest level of the year.

The yield spread between Treasury’s three-month bills and 10-year notes is a proxy for how investors see Fed policy affecting economic activity. It became inverted in October 2022 as the Fed was raising rates.

When it had been inverted for 13 months last December, Campbell Harvey — the Duke University professor who first established the predictive qualities of an inverted curve back in the 1980s — said it amounted to a recession threat that the Fed should address via rate cuts.

What Bloomberg strategists say…

“The disinversion of the three-month versus 10-year curve will make it more attractive for carry traders to buy longer-term debt, reducing the chance of an abrupt withdrawal of leverage from the system, and allowing deeply negative swap spreads to rise.”

— Simon White, macro strategist. Read more on MLIV. 

Read: Pioneering Yield-Curve Economist Sees US Able to Dodge Recession

The shifting Fed policy outlook “has caused a lot of volatility in the short-end of the yield curve which filters into the curve,” said Vineer Bhansali, founder of the Newport Beach, California-based asset-management firm LongTail Alpha. He said the firm had invested for a steeper yield curve, “and to the degree we’ve had more bullets to spend, we’ve added to the position.”

The possibility that economic conditions will keep inflation from slowing all the way back to the Fed’s 2% target may cause further yield-curve steepening.

The US is “in a structurally higher rate, inflation and volatility environment” than it was for most of the past two decades, Daniel Siluk, head of global short duration and liquidity, portfolio manager at Janus Henderson. “We are reticent to move further out the curve in terms of the way we invest because yield curves are still quite flat.” 

With assistance from Edward Bolingbroke and Ye Xie.

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