(Bloomberg) — Bond traders are cautiously resuming bets that burned them just weeks ago, as the Federal Reserve and its major global peers finally appear ready to start cutting interest rates as early as June.
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Previous bets that central banks would quickly ease monetary policy in 2024 backfired after authorities continued to focus on above-target inflation and resilient demand. But last week’s surprise cut in Switzerland and the dovish outlook from Fed Chairman Jerome Powell and his counterparts at the Bank of England and the European Central Bank give investors reason to reposition themselves in favor of relaxation.
Among money managers such as Pimco and BlackRock Inc., as well as former bond king Bill Gross, the prospect of lower rates is boosting the appeal of shorter-term bonds, maturing in about five years or less , which should benefit the most from rising rates. – cut off speculation.
This type of outperformance relative to longer maturities is a recipe for so-called steepening bets, where the yield curve reverts to a traditional upward slope. Of course, there is always a risk that central banks will fail to justify their optimism about shorter maturities, given that inflation remains stable and labor markets continue to be resilient.
“Whether we’ll actually get what’s in the price is debatable, but for the current direction of travel, the promise is all that matters right now,” said Jim Reid, global head of the economics and thematic research at Deutsche Bank AG. As markets focus on a “dovish narrative, it’s worth keeping in mind that sentiment around rates has changed over the course of 2024,” he said.
Indeed, Reid and his colleagues estimate that markets have swung toward dovish policy seven times this cycle and that the last six times the results have actually been hawkish.
2023 sparkle
For now, investors are feeling a preview of what happened in late 2023. At the time, the Treasury market appeared poised for a third straight annual loss, but it recovered late in the year. year as global markets expected policymakers to cut rates in early 2024.
Although they now appear in sync, central banks could end up moving at different paces, which could provide opportunities to make money.
“It’s likely that major central banks like the ECB, the Fed and the BOE will all start cutting rates in the middle of this year, and that’s where the similarities end,” said Michael Cudzil, manager of portfolio at Pacific Investment Management Co., at Bloomberg Television. . “Speed and destination vary across the world, which is ideal for fixed income opportunities.”
Rates traders are looking to June as the start of the Fed’s easing cycle, after starting the year expecting a March kickoff. For all of 2024, they forecast slightly more than Fed officials’ median forecast of 75 basis points of cuts. June is also when markets expect the ECB and BOE to start cutting rates, with at least several measures being considered by both.
Among major central banks, the Bank of Japan stands out, with economists predicting it will raise rates again by the end of the year, after abandoning its easing program last week.
What Bloomberg strategists say…
“If central banks do what they want, we could have first rate cuts from the Fed, ECB, BOC and BOE by the end of the first half. This means that initial yields in major economies will continue to fall because there is no point in fighting central banks.
— Ven Ram, strategist
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Electoral twist
Kellie Wood of Schroders Plc in Sydney said the dovish turn by most major central banks “means the bond market is likely to be one of the best performing markets this year.”
She nevertheless believes that there are margins of divergence, particularly in the run-up to the American presidential election in November.
“There’s a small window for the Fed to cut maybe 50 basis points before the election, but we think that’s as good as it gets,” said the firm’s deputy head of fixed income. Its portfolio is neutral on the US short term, while being bullish on European short term bonds and UK gilts.
The U.S. Treasury curve briefly steepened after the Fed meeting, but two-year yields remain about 40 basis points above 10-year rates. The curve has thus been inverted, or inverted in traders’ language, since around mid-2022.
Complicating investors’ calculations about the extent of the coming steepening, Fed officials revised their inflation and growth outlook upwards last week and reduced the number of cuts they anticipate over the course of the year. of the next two years.
The revisions for 2025 and 2026 “show that we are going to have a cycle of superficial easing,” said David Rogal, a portfolio manager in the fundamental fixed income group at BlackRock.
This suggests “some steepening of the curve,” he said, and for this reason the group “underweights intermediate and long rates – seven to 30 years – in our portfolios”.
What to watch
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Economic data :
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March 25: Chicago Fed national activity index; Bloomberg US Economic Survey; sales of new homes; Dallas Fed Manufacturing Activity
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March 26: Philadelphia Fed non-manufacturing activity; durable goods; capital goods; FHFA Home Price Index; S&P CoreLogic; Conference Board Consumer Confidence; Richmond Fed Manufacturing Index and Business Conditions; Dallas Fed Services Activity
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March 27: MBA mortgage loan applications; wholesale stocks (revisions)
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March 28: GDP (Q4); personal consumption; GDP price index; Initial jobless claims; pending home sales; INM Chicago PMI; University of Michigan Sentiment and Inflation Expectations; Kansas City Fed Manufacturing Activity
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March 29: Personal income and expenses; PCE deflator; improve the trade balance of goods; retail and wholesale stocks; Kansas City Fed Services Activity
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March 29: Good Friday. Closure of trading on US markets
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Fed Timeline:
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March 25: Raphael Bostic, president of the Atlanta Fed; Governor Lisa Cook
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March 27: Governor Christopher Waller
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March 29: Mary Daly, president of the San Francisco Fed; Powell
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Auction schedule:
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March 25: invoices from 13 to 26 weeks; 2 year notes
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March 26: cash management invoices at 42 days; 5 year notes
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March 27: 17-week bills; 2-year variable rate notes; tickets at 7 years old
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March 28: invoices 4 to 8 weeks
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–With assistance from Edward Bolingbroke and Greg Ritchie.
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