Aug 2 2024:Â Following numerous false starts, investors are now eager to secure what are still some of the highest government and corporate bond yields in 15 years before they disappear as central banks begin easing monetary policy in earnest.
Encouraged by headline inflation returning to target levels and anticipated tax increases from the new British government, the Bank of England narrowly voted for its first interest rate cut in four years this week. This move came just 24 hours after the U.S. Federal Reserve signaled it was prepared to cut rates in seven weeks’ time.
Despite the cautious rhetoric and emphasis on “data dependency,” these two central banks are merely catching up with the actions already taken by central banks in the euro zone, Switzerland, Sweden, and Canada.
With real inflation-adjusted policy rates rising sharply to their tightest levels since the global banking crash of 2008, labor markets loosening, and manufacturing growth stalling, there appears to be a consensus that now is the time to act to avoid scrambling later if the economic slowdown worsens.
Short-dated government bonds are leading the charge.
Two-year U.S. Treasury yields have dropped by a cumulative 50 basis points (bp) in the space of a month, reaching their lowest levels since February. Similarly, two-year UK gilt yields have fallen as much, hitting their lowest levels in over a year.
This decline has been seen across the curve, with 10-year Treasuries dipping below 4% for the first time in six months. Europe has also experienced a rally, with even recently volatile French 10-year government yields falling below 3% for the first time since a contentious snap election was called in June. The Bloomberg Multiverse index of global government and corporate bonds has seen implied yields plummet below 4% again, reaching their lowest levels since early February.
Leak Out the Curve
There have been false dawns before.
The combination of creeping industrial slowdowns, better-behaved inflation, and caution towards many pricey equity markets suggests that still-brimming coffers of cautious cash may now start to leak out as short-term money market rates tumble.
The rush to secure longer-term fixed returns in bonds while yields are still historically high seems a likely first step.
And there’s still a lot of money in cash.
According to ICI data, total assets in U.S. money market funds rose to a record high of $6.14 trillion this week, almost $1.6 trillion more than before the Fed started raising rates in March 2022.
The question is whether it’s now worth shifting to much lower longer-term yields.
Anticipating a Fed move from its 5.38% policy mid-rate in September, three-month Treasury bill rates have slipped 10 bp over the month to 5.28%, but they remain 110 bp above the fast-disappearing two-year yield at 4.2%.
Yet, futures markets already price in a likely series of Fed cuts that would bring policy rates below the current two-year Treasury by March of next year. Two-year notes themselves would almost certainly be far lower by then if that scenario unfolded. All things equal, the current rates universe suggests a new two-year note bought today would yield more than a three-month T-bill for 18 months of its maturity.
Analysts at TS Lombard earlier this year calculated that current two-year yields are still attractive even if you assume the 200 bp of Fed easing in this cycle now priced by futures markets “normalizes” the yield curve and returns a premium on two-year yields over Fed policy rates to a 50-year average of 30 bp.
Even if 200 bp sounds like a lot of easing, bear in mind that would still leave Fed policy rates at twice the 20-year average and almost 60 bp above what Fed policymakers see as long-term neutral—still ‘restrictive’ in the parlance of the U.S. central bank.
The upshot is that the temptation to move cash holdings further out the curve may now prove irresistible, and bond markets seem to see that wave coming at last.
The opinions expressed here are those of the author, a columnist for Reuters.
(by Mike Dolan X: @reutersMikeD: Editing by Paul Simao)
