Treasury yields fall as traders bet on US rate cuts

January 16, 2024, 1:13 PM

Federal Reserve chair Jerome Powell. The Fed has set its benchmark Effective Rate of interest at 5.33% but the markets expect a cut

10-year treasury yields falling
US interest rate cut expected
GCC likely to follow

US 10-year treasury yields have slid from October’s 15-year highs as markets bet the Federal Reserve will start cutting its benchmark interest rate in 2024.

Declining 10-year treasury yields, against which many sovereign and corporate bonds worldwide are priced, have led to lower borrowing costs.

“We’re starting to see some more new issuance in 2024, nothing major yet, but that may change as we go through the year,” said Robin Marshall, director of global investment research at FTSE Russell in London.

Five of the six GCC national currencies are pegged to the US dollar, while the Kuwaiti dinar is linked to a basket of currencies in which the dollar dominates.

As such, Gulf policymakers must mostly follow US rate moves to maintain the dollar pegs, so Fed decisions have a direct impact on Gulf economies. Saudi Arabia, the UAE and Kuwait also each hold multibillion-dollar US treasury portfolios.

Yields on 10-year US treasuries topped 5 percent in late October for the first time since 2007. However they have since retreated to 4 percent on Tuesday following more dovish comments from the US Federal Reserve that strengthened expectations for extended rate cuts this year.

The Fed’s Effective Rate, considered the US benchmark interest rate, is at a two-decade high of 5.33 percent as part of attempts to cool inflation.

Recent US economic data has reawakened recessionary fears, boosting market confidence that the Fed will begin cutting its benchmark interest rate.

“Whether that proves to be a pivot or a pirouette remains to be seen,” said Marshall.

These factors helped to lower the yield on 10-year treasuries.

“We see this quite often near a cyclical turning point in rates – there’s a tendency for markets to front-run Fed easing even if it doesn’t always pay off,” said Marshall.

Just such a scenario occurred last year, when the Fed confounded expectations by raising rates further, rather than reducing borrowing costs, as the US economy proved more robust than many had forecast.

Refinitiv data indicates traders expect the Fed to cut rates by about 125-130 basis points this year, while guidance from a Fed December report suggests a 75 basis point reduction, Marshall noted.

The global financial crisis and the Covid-19 pandemic were two enormous deflationary shocks that led most major central banks worldwide to slash benchmark interest rates to near-zero in response.

But the gradual disinflation in this cycle is different, and without a similar-sized shock, markets should not assume rates will return quickly to such levels again, said Marshall.

Chicago Fed data shows financial conditions are no tighter now than when the Fed began raising rates in March 2022, Marshall explained.

“So, does the Fed really need to rush reducing rates?” he said. “There’s no real sign of a recession being imminent. One of the surprises of 2023 was that despite widespread forecasts of recession, after the inversion of the yield curve, it never materialised.”

This suggests US 10-year treasury yields could be volatile within a range of 3.5 to 5.0 percent in 2024, said Marshall.

“If economic growth has a soft landing, there’s little incentive for the Fed to lower rates suddenly towards zero again,” he said.

Nevertheless, lower inflation will spur the Fed to cut benchmark rates because otherwise it makes real rates – borrowing costs in relation to inflation – higher.

“That’s partly why the market’s expecting the Fed to do more to prevent real rates from squeezing the economy into recession,” said Marshall.