Bonds Look Towards Fed Rate Cuts

Long-end U.S. Treasury bonds hit their highest levels since the middle of September as rate cut odds for 2024 have surged in recent weeks. The U.S. 10-year yield drops to 4.183%.

• Long-end U.S. Treasury bonds hit their highest levels since the middle of September.
• Rate cut odds for 2024 have surged in recent weeks, with greater than a 65% chance of a 25bps rate cut in March.
• Bond volatility continues to come down but remains relatively elevated in 30s (/ZBZ3) and ultras (/UBZ3).

After a rampant run higher in November, U.S. Treasury bonds are continuing to exhibit strength in the early days of December (as they are seasonally wont to do).

Two-year notes (/ZT) are almost back to breakeven on the year, while 10-year notes (/ZN) and 30-year bonds (/ZB) are racing to their highest levels in almost three months. It remains the case that “if the trend is your friend, then the trend is for high bond prices and lower yields, particularly at the long end of the curve.”

/10Y U.S. 10-year note yield technical analysis: daily chart (May to December 2023)

Today found fresh monthly lows in the U.S. Treasury 10-year yield. This marks a continuation of the trend that’s been playing out since early-November, when the /10Y fell below the rising trendline from the May, July, and September swing lows, as well as the neckline of a head and shoulders topping pattern around 4.472%.

Momentum is still pointed lower, with /10Y below its daily 5-, 13-, and 21-dat exponential moving average (EMA) envelope (which is in bearish sequential order), slow stochastics holding in oversold territory, and moving average convergence/divergence (MACD) is trending lower below its signal. Ultimately, the head and shoulders pattern moved down to 3.931% before the current technical thrust was completed.

/ZB U.S. 30-year bond price technical analysis: daily chart (May to December 2023)

The long end of the bond curve continues to stage the most impressive turnaround of any portion of the curve.

In the pre-Thanksgiving commentary on bonds, we noted that “a short put vertical (long 108 put/short 110 put) for [the Dec. 29 expiry] 38DTE, the POP is 91%.” Now, the same expiry (24DTE) has a 97% POP. The October and November outlooks for the bottom having formed in bonds is vindicated, particularly now that /ZBZ3 is trading above 119, meaning it has scaled the lows formed in October 2022 and August 2023.

The momentum profile remains thoroughly bullish. /ZBZ3 is above its daily EMA envelope, which is in bullish sequential order. MACD continues to trend higher above its signal line, and Slow Stochastics are holding in overbought territory.

Are Fed rate-cut expectations appropriate?

There is a fly in the ointment, however. Much of the rally in bonds has occurred alongside a rapid escalation of Fed rate-cut odds.

There is now greater than a 65% chance of a rate cut of 25-basis-points (bps) in March 2024; in total, there are five 25bps rate cuts priced-in for 2024, with a 46% chance of a sixth 25bps rate cut by December 2024 (meaning 136.5bps worth of cuts are already discounted for next year). For these rate cuts to be realized, it would mean that the Federal Reserve would not be staying “high for longer,” and indeed would likely be facing down a recession for the U.S. economy.

Something must give out soon. We will see either a meaningful deterioration in U.S. economic data (which, to be fair, has been happening) to justify the current rate cut pricing structure; or bond prices will need to correct to the downside as the market recalibrates rate cut expectations to something more in line with what the Federal Reserve has been suggesting.

Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multinational firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx  

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