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Bonds Digest Aggressive Fed Cut Pricing

By:Christopher Vecchio - CFA

The door has seemingly opened for five or even six interest rate cuts in 2024

  • U.S. Treasury bonds have rallied meaningfully in December, with the short-end and belly of the curve returning to their opening levels of the year.
  • Rate cut odds for 2024 have bounced post-FOMC, with the odds of six 25-basis-point cuts up to 58.9%.
  • Bond volatility has come in but remains relatively elevated at the long-end of the curve.

Year-to-date price percent change chart for /ZT, /ZF, /ZN, /ZB, /UB
Year-to-date price percent change chart for /ZT, /ZF, /ZN, /ZB, /UB

Market update: U.S. 10-year yield down to 3.952%

The December Federal Open Market Committee (FOMC) meeting sent U.S. Treasury yields spiraling lower as Federal Reserve Chair Jerome Powell seemingly opened the door for rate cuts sooner than previously discussed (at least publicly). Rates markets (per Fed funds futures) are now fully discounting five 25-basis-point (bps) rate cuts in 2024, with a 58.9% chance of a sixth cut by the end of 2024.

While these may be overcooked in the short-term—it’s difficult to envision the Fed cutting rates six times next year if the economy continues along its current path—it also 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,” as we’ve said for weeks. Pullbacks in 10s (/ZNH4), 30s (/ZBH4), and ultras (/UBH4) should be faded, for now.

/10Y U.S. 10-year Note Yield Technical Analysis: Daily Chart (May to December 2023)

/10Y U.S. 10-year Note Yield Technical Analysis

For the better part of two months, it’s been noted that “the head and shoulders pattern has a measured move down to 3.931% before the current technical thrust is completed.” Last week, the U.S. Treasury 10-year yield (/10Y) hit a low of 3.884% before the move lower paused. If there is a short-term swing higher, perhaps because of the recent bump in energy prices and positive revisions to Q4 ’23 U.S. gross domestic product (GDP) expectations, then it would represent an opportunity for traders to establish positions biased toward lower yields.

Momentum is still bearish, with /10Y below its daily 5-, 13- and 21-exponential moving average (EMA) envelope (which is in bearish sequential order). Slow stochastics remain in oversold territory, and the moving average convergence/divergence (MACD) is still trending lower below its signal. Now that the head and shoulders pattern has been completed, traders should treat the /10Y as a pure momentum play, bearish until price action dictates otherwise.

/ZB U.S. 30-year Bond Price Technical Analysis: Daily Chart (May to December 2023)

/ZB U.S. 30-year Bond Price Technical Analysis: Daily Chart

The uptrend in the 30s (/ZBH4) remains bullish as well: the uptrend from the November and December swing lows is intact. Volatility remains relatively elevated (IV Index: 14.5%; IV Rank: 31.0), which makes selling puts appealing. A short put vertical against recent swing lows (long 116 put/short 118 put) for the Jan. 26 expiry (39DTE) offers a POP% of 70%.

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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