US bonds rallied sharply as signs of a slowing economy and a recent stock-market rout fueled calls for quicker interest-rate cuts from the Federal Reserve, further juicing bets on a steeper yield curve.
Shorter-dated securities led gains, with the two-year yield falling as much as nine basis points to 4.34% — the lowest since early February — reducing the premium paid over benchmark securities. The moves spread to European markets, boosting bunds and gilts, and prompting investors to price more easing this year by both the European Central Bank and Bank of England.
Wagers on aggressive easing by the Fed have jumped in recent days amid growing discussion of whether the central bank should act when it meets next week. Former New York Fed President William Dudley said Wednesday that US policymakers should reduce rates at that gathering. And Mohamed El-Erian warned Thursday that too long a delay on cuts could prove a “policy mistake.” Both were writing as Bloomberg Opinion columnists.
Weakness in big tech stocks has also soured market sentiment, adding to the bond market’s gains, and attention is now turning to US GDP and initial jobless claims reports for further evidence of the economy’s health.
“The bond market is driven by the rising expectation of Fed cuts in the September meeting, given the stock market rout and weaker US data as of late,” said Janet Mui, head of market analysis at RBC Brewin Dolphin. “Financial conditions have tightened in recent weeks so that argues for some policy easing to be brought forward.”
Easing Wagers
While US money markets still suggest a move by the Fed this month is highly unlikely, traders are pricing about 30 basis points of easing by September, suggesting about a 20% chance of a supersized cut. Nearly 70 basis points of cuts are seen through 2024, five basis points more than on Wednesday.
Meanwhile, traders see a cut next week in the UK as a coin-toss, and expect 55 basis points of reductions by the European Central Bank this year.
The move in US Treasuries boosted a revival of so-called steepeners, which wager on the difference between yields on short- and long-dated debt and have been a favored trade of investors who expect Donald Trump to win the presidential election in November.
The difference between two- and 10-year yields, a closely-watched part of the yield curve, narrowed to less than 12 basis points — the smallest margin since October 2023 and within striking distance of ‘dis-inversion.’
The US bond curve has been inverted for years as the Fed keeps monetary conditions tight, meaning short-term Treasuries yield more than long-term ones. That’s in contrast to conventional thinking about debt, which would see longer-maturity securities pay a premium to compensate investors for the additional risk embedded within their longevity.
“Inverted curves don’t paint a picture of a typical bond market and so we do think that steepeners are where we would prefer to be at this point,” said Eva Sun-Wai, a global government bond fund manager at M&G Investments. “Regardless of your view on politics or growth going forward, I think it’s fair to say there needs to be more term premium priced at the long-end.”
Debate over US easing coincided with a rate cut in China and further evidence that Europe’s recovery is struggling.
The People’s Bank of China unexpectedly lowered the cost of its one-year policy loans by the most since April 2020 earlier Thursday, acting days after cutting a key short-term rate in a sign of greater support for the slowing economy.
“We see what’s going on with China – they seem to be, I wouldn’t say panicking, but they’re suddenly cutting rates,” said Matt Maley, chief market strategist at Miller Tabak + Co. in a Bloomberg TV interview.
“And suddenly, we’re here talking about maybe a sooner cut in the US in July or 50 basis points in September. The concern is, what’s really going on with the economy: is it really slowing a lot more quickly than people had been thinking? If that’s the case, then sentiment is going to change very quickly,” Maley added.
Meanwhile in Germany — the region’s biggest economy — the business outlook unexpectedly darkened just a day after data showed a shock plunge of the S&P Global Purchasing Managers’ Index. French business confidence posted a similar slump, reaching levels not seen since the Covid-19 pandemic as companies reckoned with the turbulence of snap elections.
The German two-year yield fell as much as eight basis points to 2.58%, the lowest since February.
“Poor sentiment data in Europe gave the move some legs in our region,” said Reinout De Bock, head of European rates strategy at UBS Group AG. “I see further bull steepening.”
The broader risk-off mood also weighed on European bond spreads. The gap between French 10-year bonds and safer German peers increased to 72 basis points, the widest since early July. And the equivalent Italian spread has climbed 11 basis points over the past three days to 139 basis points.
Political developments and geopolitical tensions mean safe assets like sovereign debt are primed to perform, said Antonio Cavarero, head of investments at Generali Asset Management.
“The view remains favorable towards government bond investments, particularly in Europe, where the monetary policy path seems clearly outlined,” he said.
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