In a December 14 Barchart article, Bond Prices: How High They Can GoI wrote:
In late October, US 30 Treasury Bond futures hit what was an unsustainable low at 107-04 before recovering to a recent high above 123. While the long-term trend remains lower, the bonds ran out of bearish steam and moved . in a short-term bullish trend.
The US long bond futures returned to above the 119 level on January 26. While the near-term trend has turned bearish, the odds of a return to the late October lows are low.
Bond futures are retreating
The bearish trend since the March 2020 high took the continuous US 30-year Treasury Bond contract to a low of 107-04 at the end of October 2023, where it sold out.
Like the diagram outstanding, the long bond futures increased from the low of October, reaching 125-30 at the end of December. Over the past few weeks, the bonds have retreated below the 120 level and were at just under 121 on January 25th. While bonds have rallied from the October 2023 low, the longer-term trend since the 2020 high remains bearish, with technical resistance at. 125-30 and 134-14, the April 2023 high.
Inflation stabilized – December data was mixed
A significant reason for the bond rally was the trend in inflation data over the past months. The highest inflationary pressures since the 1980s led the US central bank to tighten credit, pushing the Fed Funds Rate from zero in March 2022 to 5.375%. Quantitative tightening to reduce the Fed’s bloated balance sheet has moved rates higher further along the yield curve.
With consumer and producer prices stabilizing and easing during the final months of 2023, bonds rose as tightening pressure eased.
The December data showed that CPI came in slightly warmer than expected, but PPI balanced the inflation fears with a marginally lower than expected reading. The Fed’s favored December PCE gauge fell to 2.9%, the lowest since 2021. As a result, bond prices stabilized in early 2024 at higher than the October low but lower than the late December peak.
Don’t expect much from the Fed in an election year
The mission of the US central bank is stable prices and full employment, and although some people may disagree, the Fed tries to be an apolitical body. The president appoints the Fed chairman and governors, and the Senate approves the appointments. In 2024, the contentious election that looks like a repeat of the 2020 contest will likely cause the Fed to tread carefully to avoid any significant economic consequences that give an advantage to the incumbent or challenger.
Therefore, the markets should expect little from the Fed in 2024. While the late 2023 rally in bonds came at a price on growing expectations for lower interest rates in 2024, any rates are likely to be nominal, within 25-50 basis points.
Markets have adjusted to the current exchange rate environment
The US stock market rose to record territory, a testament to the market’s adjustment to the higher interest rate environment. While fixed-income assets caused some capital to flow from stocks to bonds in October 2023, depressing the major indexes, the decline in inflationary pressures caused stocks to come back on top.
After the sticker shock caused by the increase in 30-year conventional mortgage rates, which took them from below 3% at the end of 2021 to more than 8% in October 2023, rates fell below the 7% level. We could see an increase in new home purchases and construction in the spring of 2024, as existing home sales remain tight, with homeowners holding sub-4% mortgages unlikely to sell.
Rates were much too low after the global pandemic of 2020 when the Fed Funds Rate fell to zero percent. The rise in inflation has caused rates to rise rapidly, but the recent decline has put interest rates at more tolerable levels in early 2024.
Geopolitics will dictate inflationary pressures and the Fed’s response
While economics will dictate the path of least resistance for US interest rates, the geopolitical landscape remains a clear and present danger in early 2024. Escalating tensions in the Middle East and the ongoing war in Ukraine could cause more than a few bouts of volatility in markets. across all asset classes.
Any surprises arising from the conflicts could change the Fed’s policies. In addition, the US remains the world’s leading economy, with US bonds a safe haven for investors during economic turmoil. US bonds remain in a bearish trend since the 2020 highs, but any surprises or shocks to the system could lift them to challenge the late 2023 highs or the April 2023 peak, which would end the bearish trend.
Time will tell if the recovery in the US bond market is over or if the rally has paused and we are in a consolidation period. Barring unforeseen events, the 2024 US election, which will determine the path of US domestic and foreign policy, is likely to keep bond volatility low until November.
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As of the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is for informational purposes only. For more information, please see Barchart’s Disclosure Policy here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.