Analysis: Bond rebound uncertain as Trump plans overshadow Fed rate cuts
08/11/2024 05:00
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Chance of rebound in bonds undercut by Trump's election
win
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Trump's economic plan could juice growth, temper future
cuts
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10-year Treasury yields have surged in recent weeks
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Fed lowered rates by 25 basis points on Thursday
By Davide Barbuscia and Lewis Krauskopf
NEW YORK, Nov 8 (Reuters) - Prospects of a near-term
rebound in the $28-trillion U.S. government bond market are
faltering, as Donald Trump’s return to the White House is
expected to usher in fiscally expansive policies that could
temper the extent of the Federal Reserve's future rate cuts.
The Fed lowered rates by 25 basis points at its monetary
policy meeting on Thursday, following a jumbo-sized, 50 basis
point reduction that kicked off its current easing cycle in
September.
But the outlook for further rate cuts has been clouded by
expectations that key elements of Trump’s economic platform such
as tax cuts and tariffs will lead to faster growth and higher
consumer prices. That could make the Fed wary of risking an
inflationary rebound by cutting rates too deeply next year,
denting expectations that falling borrowing costs could spur a
rebound in bonds after a weekslong selloff.
"One of the major impacts (of the election), we think, will
be to cause the Fed to lower rates more gradually than would
have been the case,” said Tony Rodriguez, head of fixed income
strategy at Nuveen. “Expected cuts in 2025 we now think will be
fewer and further apart.”
Treasury yields - which move inversely to government bond
prices and tend to follow interest rate expectations - have
surged by over 70 basis points since mid-September and recently
notched their biggest one-month rise since the 2008 global
financial crisis, according to UBS Global Wealth Management. The
move coincided with Trump’s improving standing in polls and
betting markets throughout October.
Fed funds futures show investors are now expecting rates to
decline to about 3.7% by the end of next year from the current
4.5%-4.75% range. That is about 100 basis points higher than
what was priced in September.
Strategists at BofA Global Research recently shifted their
near-term target for Treasury yields to the 4.25% to 4.75%
range, from 3.5% to 4.25% previously.
Fed Chair Jerome Powell on Thursday declined to speculate on
the impact the new U.S. administration will have on monetary
policy. He said higher yields were likely more reflective of an
improved economic outlook rather than higher inflation
expectations. Consumer prices notched their smallest rise in
more than 3-1/2 years in September.
Still, inflation expectations as measured by Treasury
Inflation-Protected Securities (TIPS) surged this week, with the
10-year breakeven inflation rate rising to 2.4% on Wednesday,
its highest in over six months.
Dan Ivascyn, group chief investment officer at bond giant
PIMCO, said he was worried about rebounding inflation forcing
the Fed to slow or pause rate cuts.
"I think the pain trade for the market over the short term
would be a situation where inflation begins to re-accelerate,"
he said.
A so-called Red Sweep scenario in which Republicans control
the White House and both houses of Congress could make it easier
for Trump to enact tax cuts and give Republicans more leeway for
their economic agenda.
While Republicans were set to hold a majority of at least
52-48 in the U.S. Senate, final control of the lower chamber was
yet unclear, with vote counting still underway late Thursday.
Andrzej Skiba, head of BlueBay U.S. Fixed Income at RBC
Global Asset Management, said he was bracing for long-term bonds
to sell off further.
“If tariffs are rolled out to the extent that we believe
they will, that could prevent the Fed from cutting rates,” he
said.
Rick Rieder, BlackRock’s chief investment officer of global
fixed income, wrote on Thursday that it would be "overzealous"
to assume aggressive rate cuts in 2025, and said bonds were more
attractive as an income-generating asset than a play on falling
rates.
WATCHING 4.5%
Rising Treasury yields have so far had little effect on the
stock market, which has shot higher as the uncertainty over the
election cleared and investors positioned for the possibility of
stronger economic growth, pushing the benchmark S&P 500 index to
a record high.
But yields could cause trouble for stocks if they rise too
far or too quickly. Higher yields offer investment competition
for equities while raising the cost of capital for companies and
consumers.
When 10-year Treasury yields neared 4.5% or went higher over
the last year, "it has triggered some pullbacks in equity
markets," said Angelo Kourkafas, senior investment strategist at
Edward Jones. "That could be a level that people are looking
at.”
Ten-year yields stood at 4.34% late on Thursday.
Others feared a return of so-called bond vigilantes -
investors who punish profligate governments by selling their
bonds - could tighten financial conditions excessively, as
higher government bond yields push up borrowing costs for
everything from mortgages to credit cards.
Trump's tax and spending plans could increase the debt by
$7.75 trillion over the next decade, according to a recent
estimate from the Committee for a Responsible Federal Budget.
Bill Campbell, portfolio manager at DoubleLine, said he was
worried about the fiscal profile of the country after Trump’s
election and was betting on a further rise in long-term yields.
“The Red Sweep complicates things,” he said.
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Inflation expectations rising https://reut.rs/4fCzHdp
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(Reporting by Davide Barbuscia and Lewis Krauskop; Editing by
Ira Iosebashvili and Shri Navaratnam)
((Davide.Barbuscia@thomsonreuters.com; +1 917 285 3067;))