① As the prospects for the Federal Reserve's interest rate cut path become increasingly uncertain, bond investors are now taking defensive measures Last week, higher than expected US CPI and mixed labor market indicators led traders to further reduce their bets on the Fed's annual rate cuts, while also pushing the 10-year Treasury yield to its highest level since July.
As the prospects for the Federal Reserve's interest rate cut path become increasingly uncertain, bond investors are now taking defensive measures.
Last week, higher than expected US CPI and mixed labor market indicators led traders to further reduce their bets on the Fed's annual rate cuts, while also pushing the 10-year Treasury yield to its highest level since July.
The Bank of America MOVE index, a closely watched measure of expected volatility in US Treasury bonds, has risen to its highest level since January.
Interest rate market traders currently estimate that the likelihood of the Federal Reserve keeping interest rates unchanged at a meeting in November or December is about 20%. As a comparison, before the release of the non farm payroll report in September, a combined 50 basis point interest rate cut from two meetings was once seen as a certainty in the industry.
At the same time, the activity in derivative markets such as options indicates that investors are hedging against a situation where the Federal Reserve has reduced the number of interest rate cuts: the recent surge in demand for guaranteed overnight funding rate (SOFR) options is focused on contracts targeting the Fed's only one rate cut this year. Some extreme bets even expect the Federal Reserve to pause its easing cycle early next year.
In the past week, the price of US treasury bond bonds has fallen sharply. The Bloomberg US bond index weakened for the fourth consecutive week and recorded the largest decline since April. The yield of 10-year treasury bond rebounded to above the 4% threshold, and the yield of 30-year treasury bond hit 4.42%, the highest level since July 30.
In last Friday's US Treasury options trading, several noteworthy put option trades were attempting to bet that the yield curve would become steeper. The target of a put option on 10-year treasury bond is that the yield will rise to about 4.5% before the maturity date on November 22, and several other large transactions are expected to reach about 4.75% at that time.
Kit Juckes from BNP Paribas wrote in a report, "The market is clearly uncertain about the outcome of the next few Federal Reserve decisions, and from the rapid rise of 10-year Treasury yields by nearly 50 basis points since mid September, the market is increasingly certain that the US economy will not have a 'hard landing'. This suggests a view that the likelihood of a 'no landing' is as high as a 'soft landing', which raises concerns that if fiscal tightening measures are not implemented, inflationary risks may reappear
How to allocate investments requires careful consideration
In this context, many industry insiders seem to find it difficult to decide whether to deploy cash in the short or long end of the world's largest bond market, making the middle of the relatively less risky curve a safe haven in the eyes of some investors.
In order to reduce vulnerability to economic recovery, potential fiscal shocks, or US election turmoil, asset management companies including giants such as BlackRock, PIMCO, and UBS Global Wealth Management are currently advocating for the purchase of five-year bonds, as they are less sensitive to such risks compared to shorter or longer similar bonds.
Solita Marcelli, chief investment officer of UBS Global Wealth Management in the Americas, suggested investing in medium-term bonds, such as treasury bond bonds and investment grade corporate bonds with a maturity of about five years. Marcelli said, "We continue to advise investors to prepare for a low interest rate environment by allocating excess cash, money market holdings, and soon to expire fixed deposits to assets that can provide more sustainable income
The US bond market will be closed on Monday for Columbus Day. However, in the coming weeks, it is clear that there may still be significant volatility in the bond market - not just related to the US election.
Due to investors waiting for the release of quarterly bond issuances by the US Treasury Department (expected to remain stable in size), the next monthly non farm payroll report, and the Federal Reserve's interest rate decision on November 7th, some industry insiders have predicted that the volatile market may continue for several weeks.
Citadel Securities warns clients to be prepared for so-called 'significant future volatility' in the bond market. The company expects the Federal Reserve to only cut interest rates by another 25 basis points in 2024.
David Rogal, portfolio manager of BlackRock's fundamental fixed income division, also stated that "as the election enters the window of options games, implied volatility will rise". The company prefers medium-term treasury bond because it believes that as long as inflation cools down, the Federal Reserve will readjust its policy cycle and push the policy interest rate from 5% to between 3.5% and 4%.
Of course, with the 10-year US Treasury yield, known as the "anchor of global asset pricing," returning to a high of around 4.1%, the current sell-off in the bond market is also causing some long-term investors to believe that the "buying zone" has arrived.
Our core view is that due to the Federal Reserve's policy remaining restrictive, the economy will indeed slow down next year. This means that for the company, there is an opportunity to extend the maturity of our investment portfolio when the 10-year yield exceeds 4%, while considering the downward trend in growth next year, "said Roger Hallam, Global Interest Rate Head at Vanguard Group, in an interview
He added that this will gradually shift the company towards a greater emphasis on bonds.