Analysis-'Slam dunk' Treasury trade becomes test of patience as yields march higher

By Davide Barbuscia

NEW YORK (Reuters) – A sell-off in the U.S. government bond market is picking up speed, as a strong economy whittles away at hopes for imminent interest rate cuts from the Federal Reserve.

Over the last month, investors have roughly halved the number of cuts they expect the Fed to deliver in 2024, amid booming job growth and stubborn inflation that have made the U.S. central bank hesitant to ease monetary policy too soon.

That has exacerbated losses in bonds, complicating the outlook for investors who had bet Treasuries would rise as the Fed cut borrowing costs. Yields on the benchmark 10-year Treasury, which move inversely to bond prices and are guided in-part by interest rate expectations, have shot to 4.35%, their highest level since the end of November.

“Coming into 2024, nobody thought that inflation could go anywhere but down. It was a slam dunk that you would win by just positioning in bonds,” said Craig Brothers, senior portfolio manager and co-head of fixed income at Bel Air Investment Advisors. Now, “that trade is not working.”

Federal funds futures on Friday showed investors pricing in roughly 80 basis points of interest rate cuts this year, compared to some 150 basis points that had been expected at the beginning of January. Expectations of when the first of those cuts will come have been pushed to June, from March.

At the same time, the 10-year Treasury yield is up around 50 basis points from its December lows. Treasury prices hit a 16-year low in October only to come screaming back on expectations that the Fed was done raising interest rates and would move to cutting them this year.

Minutes from the Fed’s most recent monetary policy meeting showed officials concerned about cutting rates too soon and broad uncertainty over how long the central bank’s benchmark overnight interest rate should stay in the current 5.25%-5.50% range. A chorus of Fed speakers in recent weeks have reiterated that view.

The Fed’s hesitation to ease policy “is going to make it very hard for rates to fall much further from here, so fast money will have a tough time holding that position,” said Rich Familetti, chief investment officer of U.S. total return fixed income at SLC Management. “The pain trade is higher rates and we will likely experience that.”


Strategists at BofA Securities are among those anticipating further losses in the bond market. The investment bank earlier this month said the 10-year yield could rise to about 4.5% in coming weeks as interest rates did not appear to be “overly restrictive.”

Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management, believes yields could go as high as 4.75% this year. “We are underweight duration, we think yields can go higher … and this will cause more volatility in markets,” he said.

Others have been looking at ways to protect against the possibility of a further decline in Treasuries.

Anthony Woodside, head of U.S. fixed income strategy at LGIMA, has recommended his clients hedge their bond portfolios with Treasury Inflation-Protected Securities, which he expects to provide protection if inflation continues to rise.

Still, there are many who don’t believe the selloff in the Treasury market will last. The U.S. central bank late last year projected 75 basis points of rate cuts this year – a forecast Fed Chair Jerome Powell said earlier this month was still likely in line with policymakers’ views.

The expected direction of rates is more important than the timing of rate cuts, said Vishal Khanduja, co-head of the Broad Markets Fixed Income team at Morgan Stanley Investment Management. He believes the recent surge in yields is a “mid-cycle correction” and that interest rates will eventually decline, bolstering the case for owning bonds.

Even though it’s a bumpy road, the direction of travel for inflation and the Fed is downwards,” he said.

(Reporting by Davide Barbuscia; Editing by Ira Iosebashvili and Paul Simao)

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