A bond market rebound may be in the works after weeks of volatility that sent yields to their highest levels in years.
Investors have been struggling against a global sell-off in government bonds lately, with Treasury yields rising again after the Fed announced its first rate hike in three years on Wednesday.
The yield on the 10-year US Treasury rose back above 5% as investors took in the rate decision, with some investors pricing in as many as two additional rate hikes through the end of the year. The rate hike came as investors have been fleeing US government debt amid fears about inflation and an uneasy fiscal outlook.
But fears seemed to subside on Thursday. Yields sank as appetite returned to the US Treasury market. The 10-year bond yield dropped five basis points to 4.95%, solidly below the 5% threshold that investors have eyed as a “danger zone” for stocks.
The 2-year US Treasury yield, which is the most sensitive to Fed rate moves, declined 4 basis points to around 4.68%.
Here’s what’s helping yields edge lower:
1. A sigh of relief on inflation
The Fed reiterated its commitment to bringing inflation back to its 2% target at its last policy meeting, helping to soothe anxiety about spiraling consumer prices. The fact that the Fed hiked rates may have also helped boost the Fed’s credibility, quelling concerns about Fed independence that have cropped up again as Donald Trump reiterated calls for lower rates.
The 5-year, 5-forward — a reflection of 5-year inflation expectations 5 years from now — fell 4 basis points to 2.31% on Wednesday, according to Fed data.
2-year, 5-year, and 10-year inflation expectations also dropped following Kevin Warh’s press conference, Peter Boockvar, chief investment officer at BFG Wealth Partners, wrote in a note on Substack, attributing the move to the rate hike.
“The jump in long-term inflation expectations following the July FOMC has now completely retraced,” strategists at Bank of America wrote in a note.
“Overall, in making this pivot toward a less accommodative stance, the Fed gained credibility and reaffirmed Fed independence,” Tim Horan, the chief investment officer at Chilton Trust, said.
2. Oil prices are dropping
Brent crude, the international benchmark, sank 3% on Thursday to $102 a barrel as concerns about Middle East supply disruptions eased. West Texas Intermediate crude also dropped 2%, breaking below the $100 a barrel.
Oil-supply fears had been renewed earlier in the week after Saudi Arabia’s East-West pipeline, a key alternative to the Strait of Hormuz, was closed after being attacked. The nation is now making additional oil cargoes available to Asian refiners, Reuters reported on Wednesday.
“Bonds seem to be reacting positively more so to oil than to Warsh,” strategists on JPMorgan’s market intelligence team wrote.
3. The sell-off may be exhausted
Bob Michele, global head of fixed income at JPMorgan Asset Management, said yields already reached “maximum pain,” given the extent of the Treasury sell-off in recent weeks. The bank is purchasing long-dated bonds, he told Bloomberg after the Fed meeting on Wednesday.
He speculated the US could make more progress on securing peace in the Middle East as the midterm elections approach, a development that would lower yields further.
“The long end just got too cheap and too unanchored. It’s starting to stabilize. This is the first ingredient,” Michele said. “It’s a good buying opportunity,” he added.
Other forecasters are also eyeing a recovery that’s set to push yields lower.
The sell-off in government bonds may have been overdone, economist David Rosenberg wrote in a client note. He called the decline in yields on Thursday an ongoing “relief rally.”
“The bond market may coalesce around Warshspeak and that the Fed’s commitment is enough to contain inflation expectations and bond yields,” strategists at JPMorgan said, adding that the dynamic would help lower yields.
Assuming the Fed only hikes rates one or two more times, the 10-year Treasury yield will likely be “significantly lower” within the next six to twelve months, Joe Kalish, the chief macro strategist at Ned Davis Research, wrote.
“The bond market’s biggest moves are likely now in the rearview mirror, and there is now a good opportunity for investors after this big move to lock-in these elevated yields,” Bob Edwards, the CIO of Edwards Asset Management, said.