Bonds rise as cloudy economic path supports case for Fed cuts

US Treasuries extended gains as markets took reassurance that policymakers at the Federal Reserve are still on a path toward lower interest rates.

The advance on Thursday pushed yields on five-year notes below 4% for the first time since mid-March, with action in the options market indicating traders see a further drop in the next month. The two-year rate, most sensitive to changes in monetary policy, slid to 3.96% after falling as much as seven basis points on Wednesday. 

Traders priced in around 66 basis points of rate reductions from the Fed by year-end, with the next move expected in July.

Thursday’s moves build upon those seen after the Fed’s March policy meeting, which vindicated traders who had piled into the US bond market in recent weeks. Even as Chair Jerome Powell swatted away the recession worries that have shadowed Wall Street — which helped support the equity market — investors embraced Treasuries as he highlighted the uncertainty behind the outlook.

That underscored the shift in the market’s focus “with greater emphasis now placed on the risks of weaker growth outcomes, rather than the inflationary concern,” said Dan Siluk, a portfolio manager at Janus Henderson. He called it “a slightly less-hawkish tone than many on Wall Street anticipated.”

In the options market, there were signs of heavy buying into a strategy that targets a yield drop in five-year notes to about 3.55% by April 25 — a level last seen in October. Open interest rose for a sixth straight session in 10-year note futures, consistent with new long positions added since the Fed’s announcement.

“The front end will be anchored by where the funds rate sits, and the back end should also be anchored somehow by inflation expectations, which are not falling,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. 

For bond investors, Powell’s main messages on Wednesday were that US growth is likely to slow, any inflation pickup should be transitory, and interest rates will probably come down before the year is out. He also said that “uncertainty today is unusually elevated.”

The comments and forecasts came on the heels of a tumultuous few weeks in markets as investors re-calibrated their expectations amid growing speculation that President Donald Trump’s trade war and spending cuts will drag on growth. The market therefore seized on the fact that the central bank dialed back its growth forecasts for this year, validating some of the concern. His remarks also supported speculation that the Fed will cut interest rates twice in 2025, as policymakers indicated with their latest projections.

“It was pretty masterful from Powell to be able to pull off preserving optionality once again,” said Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management, on Bloomberg TV. The path forward for Fed policy may be clearer after April 2, when the White House is set to flesh out its trade policy, she added. 

The risk, however, is that inflation brought on by tariffs could still lead to a domino effect that causes price pressures to become more persistent than the central bank expects, Apollo Management’s chief economist Torsten Slok said on Bloomberg Television on Thursday. 

Still, “markets welcomed these projections,” said Christophe Boucher, chief investment officer at ABN Amro. “No hike is on the horizon now, as Powell only mentioned the possibility of a cut or pause.”