Good news for traders in Fed waiting game

FILE- This June 6, 2019, file photo shows the U.S. Treasury Department building at dusk in Washington. (AP Photo/Patrick Semansky, File)

NEW YORK: Bond traders who are stuck in a waiting game over US Federal Reserve (Fed) rate policy will soon get some welcome support.

Starting tomorrow, and for the first time since the early 2000s, the Treasury Department will launch a series of buybacks targeting seasoned and harder-to-trade debt.

Then in June, the US central bank is set to begin tapering the pace of its balance sheet unwind, known as quantitative tightening (QT).

Both moves will offer support to a treasury market that’s been upended this year as investors radically readjusted their expectations for rate cuts in the face of persistent US growth and surprisingly sticky inflation.

The government efforts should aid the ability to trade at a time when treasuries have already settled down notably following some pockets of volatility.

“The buybacks will be helpful and will be a good backstop,” said Jay Barry, co-head of US rates strategy at JPMorgan Chase & Co.

“And the slowing of the Fed’s quantitative tightening will be helpful as it’s prudent risk management that should allay the concerns that we will have a repeat of the 2019 crisis in overnight funding markets,” he said.

Treasury yields have declined since the start of May, leaving US bonds on course for a monthly gain of 1.4%, as measured by a Bloomberg index.

The US two-year note ended last week at around 4.95%, towards the upper end of this month’s 4.7% to 5.03% range, reflecting some mixed data as well as signalling from a slew of Fed officials that they’re prepared to keep rates higher for longer.

And while some central bankers have even indicated a willingness to tighten policy further if warranted, derivative markets don’t see that as a likely, helping to keep bond yields from breaking out on the upside.

US swaps contracts are now pricing in around 32 basis points of Fed rate cuts for all of 2024, reflecting market expectations for only one quarter point rate reduction as a sure thing.

Traders had pushed their pricing to about 50 basis points after the release of softer-than-expected inflation data for April, only to backtrack a bit more recently.

The US market was closed yesterday in observance of the Memorial Day holiday. Two days later, the buybacks start.

Through a series of weekly operations slated so far through the end of July, the Treasury will buy up some of its existing government debt, purchasing older securities and ultimately replacing them with larger current issues.

The aim is to bolster the ease of trading, as older securities are typically the least liquid.

Treasury market liquidity, which has been challenged several times in recent years, has gotten better this year.

A JPMorgan Chase & Co measure of liquidity known as market depth – based on the average size of the best three bids and offers for trades in New York – has improved to levels last seen in early 2022, before the Fed’s tightening began. It still remains about 45% below its decade-long average.

Also lending support is the prospect of less QT next month. The Fed will lower the monthly cap on how much treasuries it will allow to mature without being reinvested, to US$25bil from US$60bil, while keeping the cap for mortgage-backed securities unchanged at US$35bil.

With the Fed seen on hold and waiting for high rates to eventually slow the economy, the bond market is settling into ranges and in turn, the ICE Bank of America MOVE Index – a gauge of bond volatility that tracks anticipated swings in treasury yields based on options – has slipped to its lowest since February 2022.

The tumble in the MOVE picked up over the past week, with the gauge posting its biggest streak of consecutive declines since June 2023 in the wake of consumer price data that showed underlying inflation slowed in April.

“There has been a lot of volatility in bond yields this year, and there was a sigh of relief since the consumer price index,” said Neil Sutherland, portfolio manager at Schroder Investment Management. The report suggested treasury yields have seen their peaks for the year, he added, and the easing in volatility has been “most important for the mortgage sector”.

“The US treasury market may rally by the end of year as the economy slows from the recent frenetic pace,” Bloomberg Intelligence said

“The Fed will be cutting asset runoff in June, just as the Treasury Department will begin liquidity support buybacks. Incrementally, market liquidity could be supported.”

Positioning in the bond market has also become more balanced, with data suggesting new short wagers have appeared amid slight unwinding of well-entrenched long bets. Some investors are looking to early June data, including the May employment on June 7.

Stephen Bartolini, a fixed-income portfolio manager at T. Rowe Price, sees buybacks working to marginally help trading and the reduced Fed QT helping to support overall liquidity in the economy and banking system. — Bloomberg

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