Global bonds rallied as traders bet the Federal Reserve and fellow central banks will turn more aggressive in cutting interest rates amid mounting concern that economic growth is faltering at a faster pace than expected just weeks ago.
Short-dated notes — the most sensitive to changes in monetary policy — led the move, with the US two-year Treasury yield falling as much as 19 basis points on Monday to 3.69%, the lowest in over a year. In Europe, equivalent German yields tumbled by a similar amount to 2.15%.
The global repricing was so sharp that at one point the swap market assigned a 60% chance of an emergency rate reduction by the Federal Reserve over the coming week — well before its next scheduled meeting on Sept. 18. While those odds eased off, the wager speaks to how nervous investors are becoming.
Driving the shift in sentiment is mounting evidence that the world’s largest economy is slowing and that the Fed risks having fallen behind the curve in not yet easing monetary policy.
A much weaker-than-expected jobs report last week and a tepid reading of strength in the manufacturing sector led traders to bet on at least five quarter-point rate cuts from the Fed by year-end, compared with just two expected a week ago. Next on traders’ radar is an ISM report for the services sector due Monday.
“The global easing cycle has well and truly begun,” said Michael Ford, co-deputy head of the multi-asset strategy team at Insight Investment. The “widespread nature” of cuts reflects the fact that policymakers are becoming as concerned about growth as inflation, he added.
Economists at Citigroup Inc. and JPMorgan Chase & Co. are both now predicting the Fed will lower its benchmark by a half-point at both its September and November meetings.
While bonds pared some of their earlier gains, the moves are still sizable. The US two-year yield is close to falling below the 10-year one for the first time since July 2022, a key milestone for the Treasury market. The disinversion of that key part of the curve is often seen as a signal that a recession is on the way.
Traders also amped up wagers on the extent of easing from the European Central Bank, which delivered its first cut of the cycle in June and held off moving again last month. Swaps now imply 85 basis points of additional cuts through 2024, with a 40% chance of a half-point reduction in September.
In Japan — where the central bank only just started hiking — the 10-year benchmark yield tumbled around 20 basis points as the nation’s stocks toppled into a bear market. Similar-maturity New Zealand yields slipped 10 basis points. Australia’s cash bond markets were shut for a holiday, but three-year futures surged to the highest since June 2023.
Still, some investors say the moves are overdone. Guillaume Rigeade, co-head of fixed income at Carmignac, doubts the Fed will need to deliver an emergency cut as soon as this month. Only last week, Fed Chair Jerome Powell passed up the opportunity to cut but said a move in September was on the table.
“For sure, the economy is slowing in the US, but companies are not laying off, not so much,” said Rigeade. While the Fed may well cut next month, “we are not believing that the market should price as much as it is pricing now.”
UBS Group AG’s head of European rates strategy Reinout De Bock takes a similar view and is taking profits on positions in US and European short-dated positions. He says the market is “now running ahead of data”, adding it’s not unusual to to get sharp risk-off moves in the Northern Hemisphere summer, when liquidity is lower.
The global head of fixed income at Janus Henderson, Jim Cielinski, also attributes the sharp market moves to thinner trading, as well as “overextended positions” and “crowded trades.” He has started to trim an overweight duration position in US Treasuries because the pricing is fairly aggressive now.
“I still think interest rates have room to fall but the speed of the moves have been so quick, taking a little bit of that risk down is the right thing to do,” said Cielinski.
The massive rally has pushed a Bloomberg index of global sovereign debt close to erasing all of this year’s losses, a remarkable turnaround for an asset class that has failed to deliver the lofty returns widely expected at the end of last year. The gauge is now down just 0.2% year-to-date, having lost more than 5% as recently as early July.
“There was a lot of focus on ‘normalization’ cuts, whereas if we have reactionary cuts, we know that the Fed has a lot of buffer so you need to incorporate the probability of very large cuts,” said Christian Mueller-Glissman, head of asset allocation research at Goldman Sachs Asset Management, in an interview with Bloomberg TV.
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