On Wednesday, the rally in U.S. Treasuries gained new momentum as the Bank of Japan maintained its cap on bond yields, while new data indicated a further slowdown in U.S. inflation and economic activity. The yield on the benchmark 10-year U.S. Treasury note was recorded at 3.374% by Tradeweb, a decrease from 3.534% on Tuesday, marking its lowest close since early September. The drop in yields, which occurs when bond prices rise, was initially triggered by the BOJ’s announcement to continue with large-scale bond purchases to keep the 10-year Japanese government-bond yield at 0.5%. This decision to keep the policy unchanged boosted government bonds globally as it reduced speculation that Japanese yields could continue to rise.
Favorable U.S. economic data also played a role in the rise of U.S. Treasuries, despite affecting stocks negatively. Reports on retail sales, industrial production, and supplier prices supported the idea of decelerating economic growth and easing inflation pressures. Only the index of U.S. home builders’ confidence increased slightly, but it still showed that more builders viewed conditions as poor.
Priya Misra, head of global rates strategy at TD Securities in New York, stated, “Today is very much [about] slowing growth.” She noted that the decline in yields was particularly significant among Treasuries that mature in about five years, indicating that investors believe the Federal Reserve will stop raising interest rates earlier and cut them more than previously anticipated due to increasing bets of an economic recession.
The recent movements in Treasury yields have been a dramatic reversal since the start of the year. In 2022, Treasury yields steadily increased, causing a negative impact on other assets such as stocks and leading to the worst returns for bond investors since records began in the 1970s. The 10-year yield reached as high as 4.2% in November. However, yields started to drop in the first trading session of 2023 and have fallen further than they rose to start last year.
At the start of the year, many individual and institutional investors were optimistic about bonds, drawn in by the highest yields in over a decade. Further evidence of slowing inflation and soft economic data has only reinforced their confidence that the threat of rising interest rates has diminished, allowing them to embrace these yields with greater comfort.
The Federal Reserve’s officials have sent conflicting signals to investors. While they have indicated that the days of raising interest rates by 0.75% at each meeting are over, they have also been hesitant to express too much optimism about inflation and have repeatedly indicated that they do not anticipate cutting rates this year.
James Bullard, the President of the Federal Reserve Bank of St. Louis, stated on Wednesday that a 0.5% increase in rates at the Fed’s Jan 31-Feb 1 meeting would be appropriate. He said that he expects the Fed’s benchmark federal-funds rate to be between 5.25% and 5.5% by the end of the year, which is much higher than market-based rate expectations.
However, many investors are convinced that economic data will eventually force the Fed to change its stance. According to Barbara Reinhard, head of asset allocation at Voya Investment Management, the economy is currently at a “tipping point” where consumers’ real incomes are negative and they are no longer able to purchase goods freely. Reinhard and her team added Treasurys to their multi-asset portfolios last year and have also shifted into stocks that can better withstand the recession they anticipate in late 2023 or early 2024.
Reinhard believes that although the Fed is concerned that a tight labor market may keep inflation above its 2% target despite slowing growth, inflation has already decreased and will continue to decline during a recession.
Wednesday’s bond gains and stock losses are consistent with a growing perspective on Wall Street. Classic portfolios consisting of 60% stocks and 40% bonds suffered their worst returns in decades last year as inflation and rising rate expectations impacted both assets. This year, many believe that bonds will once again serve as an effective hedge against declining stocks due to increased concerns about economic growth.
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