The Federal Reserve's recent dovish shift has led to a strong rebound in U.S. Treasury bonds, with the yield on the 10-year note, often referred to as the "anchor of global asset pricing," falling below 4% for the first time since August this year. The yield on the more rate-sensitive 2-year Treasury note has also dropped to its lowest point since May.
Last week, the Fed unexpectedly signaled a potential peak in the current tightening cycle, according to Fed Chairman Jerome Powell. This announcement has fueled a robust rally in U.S. bonds, particularly short-term bonds with yields above 4%.
Christina Hooper, Chief Global Market Strategist at Invesco, commented that the expectation of "higher rates for longer" is now dead.
The bond market is moving full speed ahead, as the market generally believes that the Fed's latest dot plot, released last week, marks the end of the "higher rates for longer" era. Just in early November, central banks around the world were still battling inflation, and the market was bracing for prolonged higher rates.
Bob Michele, Chief Investment Officer at J.P. Morgan Asset Management, sees the Fed's dovish pivot as a green light for the bond market to accelerate.
Despite New York Fed President John Williams cautioning that it's "too soon" to talk about rate cuts as early as March, his cautious remarks have not been enough to halt the strong rebound in stocks and bonds.
Some on Wall Street point out that there's still a distance to the 2% target, and rates are unlikely to drop rapidly. However, Michael Kushma, Chief Investment Officer of Global Fixed Income at Morgan Stanley, believes the Fed has shifted its focus from inflation to growth.
Kushma added that if inflation falls to the 2% target, there's no reason for the economy to be overly weak in 2024. "The Fed's decision means inflation will cool down, so we need to act accordingly."
Specifically, purchasing short-term bonds with yields still above 4% seems to be the best option. On one hand, the market's expectation of rate cuts due to the Fed's pivot has raised concerns about plummeting interest rates for cash investments. Currently, nearly $6 trillion in money market mutual funds could shift towards U.S. Treasuries.
On the other hand, long-term bonds might perform poorly due to risk premiums. Currently, long-term bonds face risks such as continued government borrowing and the possibility of inflation reigniting next year.
Lindsay Rosner, a portfolio manager at Goldman Sachs Asset Management, suggests investors target a "mix of 2 and 5 years" as "the far end of the curve is not where we see value."
However, portfolio manager Jack McIntyre prefers to "skip the 2-year and go for the 5-year and longer bonds," as he sees certain risks in whether the Fed will achieve a soft landing.
The yield curve between 10-year and 2-year U.S. Treasuries, which has been inverted for a year and a half, is flattening, and the depth of inversion is decreasing. Currently, the yield on the 10-year note is about 50 basis points lower than the 2-year note. In July, this spread exceeded 100 basis points.
A Bloomberg survey post-Fed FOMC meeting shows that 68% of respondents predict the yield curve will turn positive in the second half of 2024 or later. Meanwhile, 8% believe it will turn positive in the first quarter, and 24% in the second quarter.
Both "new bond king" Jeffrey Gundlach and "old bond king" Bill Gross, along with billionaire investor Bill Ackman, who accurately shorted U.S. Treasuries, have predicted a reversal of the yield curve.
Gross and Ackman both forecast that the yield curve might exhibit a positive slope by the end of 2024.
