Analysis: Fed Meeting Revives Treasury Bulls After Brutal Selloff

By Davide Barbuscia and David Randall

NEW YORK – Recent signs that the Federal Reserve may be nearing the conclusion of its monetary policy tightening, combined with lower-than-expected borrowing from the Treasury, are providing a much-needed boost to Wall Street’s bond investors after a prolonged selloff.

The Fed maintained its interest rates for the second consecutive meeting, with Fed Chair Jerome Powell acknowledging positive trends in inflation reduction following the central bank’s policy review on Wednesday. However, he did not suggest that a rate cut was imminent.

On the same day, the U.S. Treasury announced it would temporarily slow the rate of increases in its longer-term debt auctions, alleviating concerns that investors might demand higher yields to manage an anticipated surge in government debt.

Many bond investors have been hurt by attempts to call a bottom in a selloff that has brought Treasuries close to experiencing an unprecedented third consecutive year of losses. A potential short-term risk to the market is Friday’s U.S. payroll data, which could trigger renewed expectations of hawkish Fed policies if the figures exceed expectations.

Despite these risks, some investors are optimistic that the outlook has shifted positively. On Thursday morning, Treasuries surged, with yields on the benchmark U.S. 10-year note—moving inversely to prices—falling to their lowest level in nearly three weeks after breaching the 5% mark for the first time in 16 years last month. Overall, the market saw a rise of around 1%.

“Bonds are starting to show a little bit of life,” noted Jack McIntyre, portfolio manager at Brandywine Global. However, he cautioned that if Friday’s payroll figures surpass expectations, “then that bullishness will get tested.” McIntyre is optimistic about long-term Treasuries but plans to wait for the payroll data before increasing his exposure.

Others in the market are also expressing bullish sentiments. Notably, billionaire investor Stanley Druckenmiller, founder of the Duquesne family office, disclosed last month that he had purchased a “massive leveraged position” in two-year U.S. Treasury bonds due to growing concerns about the U.S. economy’s health.

Proponents of bond investments argue that now is the time to increase exposure to long-term securities since they could appreciate in value if an economic slowdown prompts the Fed to cut rates.

Attention is focused on indicators suggesting that the economy might be slowing beneath the surface, with plummeting savings from the pandemic, the resumption of student loan payments, and the impact of rising borrowing costs, all of which are likely to affect consumers and businesses in the near future.

The increase in Treasury yields has had repercussions beyond the bond market. The S&P 500 has lost nearly 8% from its July high, as climbing bond yields provide competition for equities while potentially escalating capital costs for companies. That said, the index remains up more than 10% year-to-date. Additionally, mortgage rates—linked to yields—rose to their highest levels in over 23 years in October.

"We’ve been trading out of equities and increasing bonds," remarked Josh Emanuel, chief investment officer at Wilshire. "The premium that investors are earning for taking equity risk is very low today compared to what they earn in government bonds."

The U.S. economy showed remarkable growth of almost 5% in the third quarter, contradicting previous forecasts of a slowdown.

Regarding future rate adjustments, Fed funds futures indicated a 17% likelihood of a rate hike in December, a decrease from 23% following the Fed’s announcement and down from 29% earlier in the week. Since March of the previous year, the Fed has raised rates by 525 basis points.

However, not everyone interpreted Powell’s remarks as dovish, with some investors cautioning that the market may be too quick to rule out the possibility of further hikes. Powell stated that it remains uncertain whether financial conditions are sufficiently restrictive to control inflation, which is still significantly above the Fed’s target of 2%. “We’ve been making progress on inflation… The question is, how long can that continue?” he said.

Greg Wilensky, head of U.S. fixed income at Janus Henderson Investors, remarked that while the Fed has not signaled an end to rate hikes, policymakers would require substantial positive economic data to consider raising rates again in December.

Wilensky, who has shifted his focus from shorter-term bonds to longer-term ones, does not anticipate significant rate increases from current levels but acknowledges that volatility in the bond market is likely to persist, influenced by elevated geopolitical risks.

Noah Wise, a senior portfolio manager at Allspring Global Investments, advised caution against excessive optimism regarding bonds, pointing out a “heightened risk” that 10-year Treasury yields could exceed 5% again if the Fed feels compelled to counter a dovish market sentiment. “The market is running with the idea that the Fed is done hiking, which they may or may not be,” he stated, warning that this narrative could pressure the Fed to remove rate cuts from their 2024 forecasts.