The U.S. Treasury market experienced its most significant rally since March, following clear indications from the Federal Reserve that it is ceasing interest rate hikes and considering cuts in 2024. This surge in Treasuries, the most substantial one-day rally in months, was triggered by the Fed’s decision to maintain its target rate range at 5.25%-5.5% while projecting a lower rate by the end of next year. Yield declines were most pronounced in short-term maturities, with the two-year note yield dropping as much as 31 basis points to 4.42%, and the five-year note falling below 4% for the first time since August. This shift reflects a significant change in market sentiment, with traders adjusting to the prospect of a more accommodating monetary policy.
The Fed's latest forecasts have led to a repricing of Fed swap rates, which now align with expectations of more than 140 basis points of easing within the next year, a notable increase from the 113 basis points anticipated before the meeting. Jeffrey Rosenberg, a portfolio manager at BlackRock (BLK) described this as a "green light for investors," highlighting the bond market’s optimistic outlook. The potential for a reversal in policy that could enhance the value of existing debt has been fueled by a quicker-than-anticipated easing of inflation, coupled with a resilient economy.
During the post-meeting news conference, Fed Chair Jerome Powell discussed the potential for rate cuts, contributing further to the yield declines. Although he cautioned that inflation remains high and additional rate increases are still possible, the bond market reacted positively to the possibility of easing. The dollar also experienced a significant decline, its largest intraday drop in nearly a month, following the Fed's announcements and Powell's remarks.
The anticipation of Fed rate cuts has been building, particularly following weaker-than-expected manufacturing data in early December. Swap markets have been increasingly pricing in the likelihood of rate cuts, with significant easing expected by the end of 2024. This optimism in the Treasury market precedes critical meetings of the Bank of England and European Central Bank, further fueling the current rally. Leah Traub, a portfolio manager at Lord Abbett & Co., suggests that while the market may be getting ahead of itself, there is a noticeable shift in the Fed’s approach. Despite the recent surge, Treasury yields are still high by historical standards, reflecting the ongoing adjustments in the U.S. economy post-pandemic.
