Macroeconomic evidence continues to support a potential start to Federal Reserve easing later this year, despite recent volatility in US Treasury yields, according to UBS Global Wealth Management.
In a note this week, UBS highlighted that the yield on 10-year US Treasuries rose 5 basis points to 4.34 percent on the final trading day of June, contributing to a near-10 basis points increase over that week.
This rise comes despite significant monthly volatility, driven in part by month-end index rebalancing. Those adjustments—where bonds sold during the month are included and some older ones are excluded—contributed to a sell-off that cut short what could have been the largest monthly bond rally of the year.
All in all, June saw a 15 basis points decline in 10-year yields, following a 17 basis points drop in May, according to the note authored by analysts led by Solita Marcelli, chief investment officer, Americas.
“However, despite the volatility in yields, the latest US data remain consistent with an economy headed for a soft landing, with the Federal Reserve’s favored inflation gauge—the core personal consumption expenditure price index—decelerating further in May,” they said, noting continued evidence that the Fed could begin its policy easing this year.
May's core PCE rose by 0.1 percent month-over-month, which UBS noted was down from 0.2 percent in April and the smallest increase this year. Annually, the pace was 2.6 percent, the slowest in over three years, significantly lower than the peak of 5.6 percent.
Earlier in June, encouraging CPI data for May reinforced the trend toward lower inflation, which had reversed in the first quarter. Real consumption growth for the first quarter of 2024 was revised down to an annualized pace of 1.5 percent from 2 percent, with the June quarter likely to reflect a similar moderation in spending that’s helping to reduce inflationary pressures.
Other indicators also suggest cooling economic activity, according to UBS. Real GDP growth for the first quarter was revised up slightly to 1.4 percent quarter-over-quarter, compared to the previous estimate of 1.3 percent, but remains well below the 3.4 percent growth rate of the fourth quarter.
Federal Reserve officials have emphasized their data-dependent approach in recent comments, the note said, with comments from Richmond Fed President Thomas Barkin and San Francisco Fed President Mary Daly suggesting a wait-and-see approach. Both acknowledged the delayed effects of high rates, with Daly pointing to inflation data that suggests monetary policy is having its intended impact.
As Fed officials view the current rate as restrictive, incoming data is expected to support rate cuts later this year, UBS said.
Market expectations for further rate cuts into 2025 are likely to drive lower bond yields by the end of the year, UBS forecasts, placing the 10-year Treasury yield at 3.85 percent. The combination of lower rates and moderate growth is favorable for diversified fixed income strategies, it said, recommending a core holding in quality bonds supplemented by satellite exposure to higher-yielding segments of the market.
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