The most effective way to deal with the monetary policy easing trend of Federal Reserve is to enhance short-term debt exposure while still maintaining yields above 4%.
It is the prevailing sentiment in the Treasury bond market as the Fed observes a decline in inflation and contemplates interest rate cuts to support a soft economic landing. Simultaneously, a portion of the nearly $6 trillion invested in money market funds has a new reason to shift towards Treasury bonds. Investors are concerned that interest rates on cash-equivalent investments may decline sharply soon. Moreover, investors increasingly believe that the economy may avoid a recession, and they are less enthusiastic about long-term equities.
The consensus on Wall Street is evident: 2-year Treasury bonds are attractive assets on the yield curve, offering a yield of around 4.4% – higher than any other maturity.
Portfolio manager Lindsay Rosner at Goldman Sachs Asset Management notes that the Fed has suggested interest rates will decrease in 2024 or 2025. Therefore, investors should focus on the 2-year and 5-year maturities.
Long-term debt is believed to have poor performance as traders seek to offset the increased risks they perceive in equities. Their concerns include the ongoing issuance of bonds to fund the U.S. government’s budget deficit, as well as the risk of inflation returning next year.
When looking at the yield curve, the two-year Treasury bond is deemed highly attractive. Over a year and a half ago, the yield curve inverted, leading long-term bonds to yield less than short-term bonds. A considerable number of investors are betting that this curve will return to normalcy next year. Currently, the yield on the 10-year Treasury bond is about 50 basis points lower than the yield on the 2-year Treasury bond. Most recently, in July, this gap widened to over 100 basis points.
In a Bloomberg market survey after the Fed meeting, 68% of respondents predicted that the yield spread would turn positive in the second half of 2024 or later. Meanwhile, 8% believed it would happen in the first quarter, and 24% thought it would occur in the second quarter.
High-profile Wall Street experts like Jeffrey Gundlach of DoubleLine Capital LP, Bill Gross of Investment Management Co., and billionaire investor Bill Ackman predict that the yield curve will shift from inverted to steep. This means short-term bond yields will decrease below long-term bond yields. Gundlach expects the U.S. 10-year Treasury yield to drop to 3% next year. Gross and Ackman believe the positive trend may emerge by late 2024.
The Fed policymakers on December 13 decided not to raise interest rates, maintaining the target range at 5.25% – 5.5%.
Officials’ quarterly projections also anticipated a 75 basis points cut next year, with the federal funds rate dropping to 3.6% by the end of 2025 and decreasing to 2.9% by 2026.
As long as data suggests the possibility of interest rate cuts, the overall sentiment in the bond market may remain optimistic. However, there are still potential pitfalls in the process, cautioned Michael de Pass, head of global interest rate trading at Citadel Securities LLC. Since most markets are anticipating a smooth landing to perfection, any deviation could lead to market repricing.
According to Bloomberg.
By. Pham Thanh Bien
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