The recent rally on global bond markets has dispelled investors’ long-held belief that interest rates will continue to rise in the US, and other countries.
For the first time in August, the benchmark yield on the 10-year US Treasury, which is used as a proxy to represent borrowing costs throughout the world, dropped below 4 percent. The policy-sensitive 2-year yield, which closely follows rate expectations, has fallen to its lowest level since May.
In recent days, other government bond markets also experienced a dramatic turnaround. Germany’s 10-year Bund Yield fell to its lowest level since nine months while its price shot up.
The Federal Reserve announced that it would not raise borrowing costs again and predicts three quarter-point reductions in 2024.Fed chair Jay Powell stated that the benchmark rate is “likely near or at its peak during this tightening period”.
Kristina Hooper, Invesco’s chief global market strategist, said: “Higher and longer is dead.” Powell wrote the epitaph this week.
Early November, the markets were bracing themselves for an extended period with high borrowing costs. Central banks had continued to fight against inflation.
In recent weeks, signs that the economy was cooling and data on softer growth in prices helped ease these concerns. This lifted bond and stock markets. The Fed’s “dot plot”, closely watched projections, on Wednesday were seen as the official signal that the “higher forever” trend was over.
On Friday, the markets reflected investors’ expectations that six US interest rates will be cut in 2024 – starting as early as March. These predictions would reduce borrowing costs for the world’s largest economy from their current range of 5,25 to 5.5 percent to around 3.9 percent.
Bob Michele is the chief investment officer at JPMorgan Asset Management and the head of its global fixed income group, which includes currency and commodities.
John Williams, the New York Fed’s president, said that talking about rate cuts in March would be “premature”. However his caution did not stop the rally.
Even as Bank of England Governor Andrew Bailey and European Central Bank President Christine Lagarde resisted the idea of rate cuts, the upbeat narrative persisted.
Stock markets were also buoyed by a positive investor sentiment this week. Wall Street’s S&P 500 closed out its seventh consecutive week of gains, and edged closer to a new record high.
Some strategists pointed out that US inflation is still well below the Fed’s target long-term of 2 percent, meaning that rates will not be falling rapidly. The US headline consumer prices index for November was 3.1 percent, down from the October figure of 3.2 percent and in line with forecasts.
Michael Kushma is the chief investment officer for broad market fixed income at Morgan Stanley. The Fed now focuses on growth rather than inflation.
He added that if the Fed is content to wait for price growth of 2 percent, there’s no need to have a weak economy in 2024. The Fed has determined that inflation is acting, so we’re off to the races”.
This week’s sharp fall in government bond rates has translated into lower debt financing costs for corporate borrowers. According to the Ice BofA Index, the average bond yield of junk-rated US corporations has dropped to less than 8%, a level last seen in early February. Thursday marked its largest daily drop in thirteen months.
The spread, or premium paid by high-risk borrowers to the US government, also shrank by 0.33 percentage points Thursday. It now stands at 3.47 percentages.
This year, there has been an increase in concern that the lowest-rated firms on both sides will have difficulty refinancing their debts in a world of higher funding costs. This could lead to an increase in defaults. According to Moody’s, junk-rated US companies will face a maturity wall of $1.87tn over the next five year.
“Even though we haven’t seen a rate cut yet, . . Hooper, of Invesco, said that the financial environment has eased significantly.
Andrzej skiba, RBC Gam’s head of Bluebay US Fixed Income, explained that the prospect of cuts is more significant for issuers of floating-rate loans than fixed-coupon bonds.
In the US high-yield bond market, a small increase could make a big difference for a company in leveraged loans and private credit.
He did note, however, that an additional slowdown in the US economy might start to impact corporate profits.