NEW YORK, Sept 19 (Reuters) – As Treasury bonds falter ahead of the outcome of the Federal Reserve’s policy meeting on Wednesday, some investors are taking advantage of the weakness and are confident the interest rate threshold will eventually be raised to help curb U.S. government debt to stimulate market.
That bet backfired several times last year as stronger-than-expected economic growth forced investors to rethink their views on when the Federal Reserve would cut interest rates to keep Treasury yields high.
Yields move in the opposite direction to bond prices.
However, investors betting on an upside believe that declining inflation and looming threats to U.S. growth in the fourth quarter make it likely that the peak in interest rates – and therefore Treasury yields – is getting closer.
“We think the Fed is done raising rates,” said Chris Diaz, portfolio manager and co-head of fixed income at Brown Advisory. “If conditions remain as they are, growth will weaken, allowing the Federal Reserve to cut interest rates,” he said.
10-year Treasury yields reached 4.366% on August 22, a high not seen since 2007. Their rise in recent weeks reflects the view that the Fed is likely to keep interest rates at current levels for longer than many investors had expected.
But others say it is only a matter of time before the Federal Reserve’s monetary tightening puts pressure on the economy and forces policymakers to cut interest rates.
Additionally, many believe that a 400 basis point increase in the 10-year Treasury yield from its post-pandemic low offers little downside potential for Treasuries.
Data from the Commodity Futures Commission showed that investors reduced their short positions in five- and 10-year U.S. bonds last week.
Net short positions in benchmark 10-year debt futures have fallen for two straight weeks, while short positions in 5-year paper futures have fallen about 18% from record levels in early August.
At the end of a two-day meeting on Wednesday, investors largely expect the Federal Open Market Committee, which sets monetary policy, to keep its federal funds rate unchanged in the target range of 5.25% to 5.50%.
Bets on futures tied to the Fed’s key interest rate priced in on Tuesday a chance of less than 30% for a rate hike in November and about 40% for a rate hike in December, LSEG FedWatch data showed. .
MAXIMUM LEVELS?
Bond yields soared last year as the Federal Reserve unleashed a flurry of interest rate hikes to counter relentless inflation that was rising to a 40-year high.
Although a crisis in the banking sector earlier this year prompted investors to invest in government bonds, it didn’t take long for yields to rise again as the Federal Reserve emphasized its “high interest rates for a long time” mantra.
Traders expect the central bank to start cutting interest rates in September 2024 based on futures prices. This compares to expectations earlier this year that rates would begin falling in January 2024.
However, investors betting on an uptrend say signs of easing pressure on consumer prices will prevent another rate hike.
Inflation, as measured by the Federal Reserve’s preferred measure, the personal consumption expenditures (PCE) price index, has fallen from its peak of 7% last summer to 3.3% in July.
And while robust growth has led most analysts to revise their forecasts for a recession in 2023, an auto worker strike, a possible federal government shutdown and a squeeze on consumer student loans loom in the fourth quarter.
Of course, unexpected strength in the economy could force the Fed to keep interest rates higher for longer, once again testing the patience of Treasury bulls.
Treasury Secretary Janet Yellen told Reuters this week that a “soft landing” scenario for the economy could withstand short-term risks such as the United Auto Workers strike and the fallout from China’s economic woes.
Anders Persson, chief investment officer of fixed income at Nuveen, said his company expects the economy to perform better than expected.
“On a scale of one to 10, with 10 being very risk-taking, we’re at a 6,” he said.
