The future of the bond market

26 Haziran 2024

Today’s market analysis on behalf of Rania Gule Market Analyst at XS.com

The future of the bond market between economic data and political drama

The bond market experienced some pressure today, Wednesday, leading to a slight rise in yields. The 10-year U.S. Treasury bonds are currently trading at 4.28%, after ending last week with a yield of 4.256%. Yields on U.S. Treasury bonds rose during Wednesday’s trading as investors considered the latest comments from Federal Reserve officials on monetary policy and awaited key economic data over the next two days.

From my perspective, yields and prices are moving in opposite directions without clear momentum within a range of one basis point, equivalent to 0.01%. Investors have absorbed statements from Federal Reserve officials regarding the U.S. economy and future interest rate expectations.

Federal Reserve Governor Michelle Bowman stated yesterday that the central bank is not ready to cut interest rates. It would be “appropriate” only when data show that inflation is sustainably moving towards the Fed’s 2% target. Bowman also did not rule out raising interest rates again.

Therefore, I believe that investors are also awaiting key economic data scheduled for release later this week, including the Personal Consumption Expenditures (PCE) price index on Friday. Since PCE is the Federal Reserve’s preferred inflation measure, it can provide indications regarding economic forecasts and the timeline for potential interest rate cuts.

Today, Wednesday, investors will monitor the release of durable goods orders, pending home sales, and weekly initial jobless claims. The final reading of the U.S. GDP for the first quarter is also scheduled for release. There might be some volatility in the bond market, but I think it will not be significant due to the current anticipation in the markets.

Notably, Indian government bonds are set to be included in the J.P. Morgan Government Bond Index – Emerging Markets (GBI-EM) starting from June 28. The inclusion will span 10 months, from Friday until March 31, 2025.

The EMEA region (Europe, Middle East, and Africa) is expected to see the biggest regional hit in index volume in the global bond market. The overall share of emerging markets in the EMEA region is expected to decrease to 26.2% by March, upon the completion of India’s inclusion, compared to about 32% at the beginning of this month.

With the addition of India, I support the expectation that Asia’s share in the index will rise to 47.6%. The significant inflows from the index inclusion are likely to boost demand for Indian government bonds and securities in the fiscal year 2025, once short-term liquidity issues in some securities are resolved. While this bodes well for keeping yields low, it may also lead to some sharp bouts of volatility in the global bond market.

I also expect yields to continue to decline amid rising bond demand, increasing expectations of interest rate cuts by the U.S. central bank, and easing inflation.

Here, I believe that investors with a medium to long-term investment horizon could consider bond funds with durations of 6 to 7 years, with holdings in India and the United States, as they currently offer a better risk-reward ratio.

I believe there is now more than a 65% chance of a 25 basis point rate cut in September 2024 already priced into the markets. This means that the Federal Reserve will not remain hawkish beyond the end of 2024, and the U.S. economy is likely to face a recession that could directly affect the bond market, especially if it is not as soft as the Fed desires.

Thus, in my opinion, we either see a significant deterioration in U.S. economic data (which is already happening) to justify the current pricing structure for interest rate cuts, or bond prices need to correct downward as the market reprices rate cut expectations more in line with what the Federal Reserve suggests.

 

Technical Analysis of US10 year bonds (US10YT) Prices:

After the significant surge in U.S. Treasury bonds in November 2023, the bond market has continued to show its seasonal strength, with the daily chart indicating levels around 4.28%.

The two-year bonds have nearly returned to break even this year, while the 10-year and 30-year bonds are accelerating towards testing their highest levels in nearly three months. Technically, the most likely scenario remains that “if the trend is your friend, the trend is for rising bond prices and falling yields, especially in the medium to long term.

Us 10 years bonds (US10YT) – Prices Chart –-XS.com

On the daily chart of the 10-year bonds, we see a rebound today from their new daily lows at 3.82%. This represents a continuation of the upward trend. When the price fell below the upward trendline from the support lows at 4.2%, it couldn’t hold and quickly returned to trade above the main trendline.

Technically, momentum still indicates consolidation between 4.28% and 4.38% in the short term, which is below the daily exponential moving averages (EMA) of 5 and 21 days, arranged in a bearish sequence at 4.30% and 4.33%, respectively. The persistence of the slow Stochastic indicator in the oversold zone and the MACD indicator pointing downward signal the likelihood of some deep corrective declines before returning to the main long-term upward technical trend.

Support levels: 4.28 – 4.25 – 4.14

Resistance levels: 4.40 – 4.60 – 4.80

 

Zaid Barem / YMM