Bond Market Euphoria Shifts to Debate Over How Low Fed Will Need to Go

A torrid bond market rally shows traders are convinced the Federal Reserve’s rate-rising cycle is over. The debate now turns to when central bankers start cutting, and by how much.

At issue is whether the economy settles in for a soft landing or spirals into something worse. Both scenarios suggest rate cuts are coming, possibly as soon as March. Current market expectations call for at least 1.25 percentage points of easing next year, a trend that would seem to clear a path for lower yields and an extended rally.

Fed Swaps Dovish Shift

That doesn’t rule out further bouts of volatility. Conflicting data may raise doubts, and Fed officials are likely to keep reminding the market that they are in no hurry to ease. Completing a big week of Fed speak before a customary pre-meeting communications blackout period begins, chair Jerome Powell on Friday said that while policy was well into restrictive territory, it was “premature” at this stage to speculate on when policy might ease. His pushback didn’t stop bond traders from sending the market even higher.

US Treasuries may well have moved too quickly, and traders have been burned before betting on a pivot prematurely. But there is a sense that yields have peaked for the cycle, and that softening data will at some point compel a chunk of the near $6 trillion of record cash sitting in money market funds into longer-dated Treasury yields above 4%. Even after a 60 basis-point drop last month, benchmark Treasury yields remain notably above the lows set earlier this year, when recession fears were fanned by US bank failures.

Treasury Yields Remain Elevated After November Boom