Bond traders consider 5% yield, potential of no rate cuts

Bond traders are readying for 10-year Treasury yields surpassing 5% as the scenario of no rate cuts by the Federal Reserve this year looks increasingly possible.

Schroders Plc is shorting US bonds across some tenors as sticky inflation raises the risk of higher-for-longer rates. Pacific Investment Management Co. expects the Fed to ease policy at a more gradual pace than peers in other developed markets, with a “non-negligible” chance that it doesn’t cut at all this year.

The views underscore a rapid shift in the global bond landscape where just a few months ago, the dominant view was for six quarter-point cuts starting in March. The chorus of bond bears is getting louder after Treasuries suffered their biggest one-day loss since August 2022 as a key US price index beat forecasts for the third straight month. 

“I don’t think 5% or higher is out of the question” for 10-year yields, said Kellie Wood, deputy head of fixed income at Schroders in Sydney. The fund is also positioning for “the chance the Fed doesn’t cut at all this year.” The asset manager holds bearish positions on US two-, five- and 10-year bonds.  

Yields on 10-year US bonds were largely steady in Asian trading Thursday after topping 4.5% for the first time since November in the previous session. Global bonds echoed the sell-off, with rate markets in Japan, New Zealand and Australia under pressure.   

While most investors still project one to two rate cuts this year, they see a growing need to hedge against a no-change scenario as solid US data push back the expected timetable. Swap traders have quickly priced out the first rate reduction to November from September, while Wall Street strategists including Goldman Sachs Group Inc. have reset their forecasts.  

“It is an option that is on the table,” Ben Emons, senior portfolio manager at Newedge Wealth in Connecticut, said of the possibility of no US rate cuts this year. As markets focus on renewed inflation risks, “the 10-year yield is setting up for full retracement to the top at 5.30%” from before the global financial crisis, he added.  

Abrdn Plc is looking to reduce duration on 10-year Treasuries and beyond as markets price in a “more resilient growth backdrop,” said Ray Sharma-Ong, Southeast Asia head of multi-asset based in Singapore. Duration typically measures the sensitivity of a bond’s price to changes in interest rates. 

 To some, the current inflation trend echoes what transpired in late 2021, when price pressures proved persistent and laid the groundwork for the Fed’s hawkish pivot. Back then, central bankers initially played down a spike in inflation as transitory, only to months later embark on the steepest hiking cycle in decades.  

“That’s been clear today as well, with investors pushing out the likely timing of rate cuts until later in the year, and pricing in a more hawkish policy stance ahead,” said Jim Reid, Deutsche Bank AG’s global head of economics and thematic research in London. 

TREASURY ROUT

To be sure, not everyone is expecting the dramatic selloff to continue.   

UBS Global Wealth Management’s Kelvin Tay said the firm would be reviewing its forecast of three rate cuts this year, but sees scope for Treasuries to rally when the Fed begins easing. 

“We do think that they’re likely to actually stabilize at the current levels before eventually heading toward the 4% level when the Fed embarks on the first cut for the year,” Tay, regional chief investment officer, told Bloomberg Television. The fund holds a long position in US rates, he added.

But a continued bout of strong readings from the US may embolden the view of those who believe in inflation’s stickiness, like Kiyoshi Ishigane, chief fund manager at Mitsubishi UFJ Asset Management Co. in Tokyo.

“There still remain upside risks to yields,” said Ishigane, who bought Treasuries this week and is continuing to hold them. “I see a 75% chance that the Fed will start cutting interest rates in September and a 25% likelihood of no cuts at all this year.”