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NEW YORK, July 30 (Reuters) – Bond investors, expecting the Federal Reserve to hold interest rates steady this week but signal that rate cuts are imminent, are betting that the US Treasury yield curve will become less inverted and eventually return to a normal positive slope.

The strategy involves bullish bets on short-dated Treasuries and reducing longer-dated exposure, a trade referred to as a “steepener” which pushes yields on longer-dated Treasuries higher than short-term maturities. Investors are compensated with a higher yield for taking risks over a longer period.

The widely watched two-year/10-year yield curve has been inverted for two years, the longest inversion in history, with the gap in yield at minus 22 basis points (bps).

With the focus on the yield curve, the Federal Reserve is widely anticipated on Wednesday, at the end of its two-day policy meeting, to keep its benchmark overnight rate in the 5.25%-5.50% range for an eighth straight meeting. Investors expect a “dovish hold” from Fed Chair Jerome Powell’s press conference at the end of the meeting, in which he is likely to signal that rates will be lowered as soon as September for the first time in more than four years.

Powell also has the Jackson Hole gathering of central bankers in late August to prepare the market for a rate cut. By then more data on inflation and this Friday’s July employment report could give policymakers the confidence they seek.

The rate futures market has priced in about 68 bps of total cuts this year starting in September, LSEG calculations showed a big jump from 30 bps just before the June meeting. Roughly three more cuts of 25 bps each are expected by June 2025.

In the Fed’s June rate forecasts the central bank had penciled in just one cut in 2024. Easing US inflation and a gradually slackening labor market have prompted a shift in rate expectations.

“The yield curve moved a significant amount in the last six weeks, but we are at these levels in October last year and it still comes down to an inverted curve, which is not normal,” said Greg Wilensky, head of US fixed income at Janus Henderson Investors, with assets under management of USD 352.6 billion.

“We’re going into a situation where the curve moves to a normal positive slope. There is plenty of room for it to go.”

BULL STEEPENERS

The spread between two-year and 10-year yields has narrowed by 30.4 bps since late June. The curve the last few weeks has mainly seen “bull steepeners,” where short-term yields have fallen more sharply than longer-dated ones, a typical prelude to the Fed’s starting an easing cycle.

Investors had bet aggressively in January on a steeper yield curve, as the markets priced in multiple rate cuts for 2024 after a dovish pivot from the Fed in December.

But those bets unraveled and the curve flattened even more as short-term yields surged above long-term ones amid a surprisingly durable economy and pesky inflation.

Going into this week’s Fed meeting, investors in the futures market sharply increased net long bets on short-dated Treasuries, such as US two-year notes, while net long positions on longer maturities have not risen as much or have declined. That mirrored bull steepeners that have been in place the last few weeks.

Friday’s data from the Commodity Futures Trading Commission showed asset managers last week increased their net long position on US two year notes to a record high.

Asset managers have also remained net long on US 5-year note futures, hitting an all-time peak in mid-July before slipping a bit last week,

“There is an urgency to get into the short end of the curve before yields start to fall in a more pronounced way,” said Chip Hughey, managing director of fixed income at Truist Advisory Services in Richmond, Virginia.

Net longs from institutional investors on US 10-year futures were largely flat last week.

“If the Fed starts its cutting cycle without a recession, buying any duration, or any longer bonds, won’t necessarily give you the same impact of being on the right part of the curve, like the 2s to 7s,” said Mike Sanders, portfolio manager and head of fixed income at Madison Investments in Madison, Wisconsin.

The firm, with USD 25 billion in assets, is currently overweight US three-year to seven-year Treasuries, reflecting expectations their yields will fall.

(Reporting by Gertrude Chavez-Dreyfuss; Editing by Alden Bentley and Leslie Adler)

 

NEW YORK – US Treasury yields slipped on Monday, with those on benchmark 10-year notes falling to two-week lows, as investors awaited this week’s Federal Reserve policy meeting in which the central bank is expected to signal the start of its rate-cutting cycle in September.

Yields on US five-year and seven-year notes, the so-called belly of the curve, slid to their lowest since March. Investors have been buying these maturities, specifically five-year notes, for the last few weeks on the belief that the long-term fed funds rate will rise. That reflects expectations that the Fed’s looming easing cycle will be a shallow one.

US five-year notes are perceived to have more upside in price, compared with 10-year Treasuries, when the Fed starts cutting rates.

Market participants estimated the Fed’s terminal rate at between 3%-3.5% as the US central bank is expected to maintain interest rates at 5.25%-5.50% for an eighth straight meeting this week.

The US rate futures market has fully priced in a rate cut in September, with about 68 basis points of cuts this year, according to LSEG calculations. This means two expected cuts of 25 basis points (bps) each, with a growing chance of a third in 2024.

“Investor expectations have really consolidated around no rate cut this week and a rate cut being priced in their next meeting,” said Bill Merz, head of capital markets research at US Bank Asset Management, in Minneapolis, citing easing inflation and a gradually slowing labor market.

“We’re seeing signals from asset prices confirming this broader, gradual deceleration as well to focus on global rate cuts.”

In afternoon trading, the benchmark 10-year yield slid 3.3 bps to 4.167% after dipping to a two-week trough of 4.151%.

US 30-year bond yields declined 3.7 bps to 4.419%.

The widely tracked US two-year/10-year yield curve deepened its inversion, or flattened to minus 22 bps, as investors unwound steepener trades put in place ahead of the Fed meeting.

Steepener trades, which involve increasing long bets on the shorter-end of the curve while reducing exposure in longer-dated maturities, are popular whenever the Fed embarks on an easing cycle. Investors buy the short end of the curve on the expectation their yields have peaked and the Fed is not going to raise rates anymore.

The US two-year yield, which typically moves in line with interest rate forecasts, was little changed at 4.383%.

The US five-year note yield fell 2.3 bps to 4.059%, while the seven-year yield eased 3.4 bps to 4.09.

Meanwhile, the US Treasury’s refunding announcement on Wednesday is expected to follow the pattern in May, when it said it intended to keep auction sizes steady for US notes and bonds over the next several quarters.

But Kim Rupert, Action Economics’ managing director for fixed income, said in a blog on Monday that officials could suggest the need for future increases, given the massive budget deficit and the ballooning debt servicing costs.

She expected the Treasury to continue boosting bill volumes to meet financing needs in the near term.

(Reporting by Gertrude Chavez-Dreyfuss and Chuck Mikolajczak; Editing by William Maclean and Richard Chang)

 

Benchmark 10-year US Treasury yields fell to a one-week low on Friday after data showed that US prices rose modestly in June, offsetting concerns about a higher-than-expected uptick in inflation following hotter-than-expected price increases for the second quarter on Thursday.

The personal consumption expenditures (PCE) price index nudged up 0.1% last month after being unchanged in May. The core PCE price index rose 0.2% last month, following an unrevised 0.1% gain in May.

Economists polled by Reuters had forecast both monthly headline PCE and core inflation rising 0.1% in June. Some economists increased their estimate, however, after data on Thursday showed core prices rising by 2.9% in the second quarter, above economists’ expectations for a 2.7% gain.

“The upside surprise angst that was instilled based on the quarterly data yesterday was to some extent overpriced, so that’s why I think that we had the relief rally,” said Vail Hartman, interest rate strategist at BMO Capital Markets in New York.

Thursday’s data also showed the US economy growing at a 2.8% annualized rate in the second quarter, double the first quarter’s 1.4% pace.

Interest rate sensitive two-year note yields were last down 5.4 basis points at 4.389%. They reached 4.34% on Thursday, the lowest since Feb. 2, before rebounding on the growth and inflation data for the second quarter.

Benchmark 10-year note yields fell 5.6 basis points to 4.2% and got as low as 4.19%, the lowest since July 19.

The closely watched yield curve between two-year and 10-year notes was at minus 19 basis points, after reaching minus 11 basis points on Thursday, the smallest inversion since October.

An inversion in this part of the yield curve is seen as a precursor to a recession, though the length of the current inversion is longer than in previous episodes. It has been negative since July 2022 and typically turns positive before an economic downturn sets in.

Attention will now turn to the Federal Reserve’s July 30-31 meeting. Traders see only a very slight chance of a rate cut next week but will watch for clues that a September reduction is coming, as is widely expected as inflation eases closer to the Fed’s 2% annual target.

Hartman noted that Friday’s data brings the three-month annualized rate for core PCE down to a year-to-date low of 2.3%, “so the more recent trend is building upon the market’s confidence that we are on a trajectory that would get us to 2% over the long run.”

Traders are also pricing in a second and possible third Fed rate cut by year-end.

The government’s employment report for July next Friday is the next major economic focus that will help guide Fed expectations.

The Treasury Department will also release its funding plans for the coming two quarters and is expected to say that it will keep most of its auction sizes unchanged for now.

(Reporting By Karen Brettell; Editing by Sharon Singleton and Emelia Sithole-Matarise)

 

TOKYO – The Bank of Japan (BOJ) is expected to unveil details of a quantitative tightening (QT) plan at its monetary policy meeting next week, aimed at reducing its holdings of government bonds.

Given the size of its balance sheet and large presence in the market, it’s a massive undertaking with various factors for policymakers and investors to consider.

Here’s what you need to know:

WHAT DO MARKETS EXPECT?

The BOJ will release plans on how it will reduce its huge purchases of Japanese government bonds (JGB) over one to two years, another step towards loosening its grip on the market and normalizing monetary policy.

While a wide range of views has surfaced, the broad consensus centers on the BOJ gradually reducing its monthly purchases of JGBs to 3 trillion yen (USD 19.52 billion) from its current pace of 6 trillion yen.

WHAT’S THE BOJ’S AIM?

Analysts say the eventual goal will be to cut its bond purchases and reduce its massive balance sheet to a level where short-term interest rates start to rise. The plans unveiled this month will be the first step in a long QT process.

It also wants a steeper yield curve that enables banks to make a decent margin from lending.

In slowly leaving the market, the BOJ wants to allow enough time for investors to absorb the bonds it will no longer purchase. It also wants to avoid a spike in yields.

Takeshi Yamaguchi, chief Japan economist at Morgan Stanley MUFG Securities, says if the central bank reduces its monthly bond buying to 3 trillion yen, the benchmark 10-year yield would only rise between 10 to 20 basis points.

HOW BIG IS THE BOJ’S BALANCE SHEET?

The BOJ’s balance sheet has ballooned over the past decade as it aggressively bought JGBs to defend its now defunct yield curve control (YCC) policy, which kept 10-year yields capped around 0%.

Its total assets as of June stood at 754 trillion yen (USD 4.90 trillion), five times the US Federal Reserve’s in ratio-to-GDP terms.

The central bank’s JGB holdings make up the largest portion, coming in at a whopping 585 trillion yen (USD 3.80 trillion). Although down from its peak ownership rate of 54%, it’s still just over half the entire JGB market.

HOW DOES THAT IMPACT MARKET FUNCTIONING?

Market functioning was hit as the BOJ expanded its ownership in the JGB market.

The BOJ’s most recent survey on bond market function stood at -24 in May, up from -29 in February and improving to levels unseen since February 2022 after the central bank ended YCC in March, but still deeply negative.

HOW LONG WILL IT TAKE TO TRIM THE BALANCE SHEET?

Shrinking the BOJ’s balance sheet won’t be quick or easy.

While no one knows how much stock the BOJ will ultimately keep on hand, Japan’s central bank held 175 trillion yen in total assets and 98 trillion yen in JGBs in April 2013 when it began monetary easing.

Economists at Capital Economics estimate it would take the BOJ about nine years to reduce JGB holdings to 100 trillion yen if it were to stop buying bonds altogether.

Analysts don’t expect the BOJ to actively sell bonds.

WHAT MATURITIES MIGHT THE BOJ FOCUS ON?

Defending YCC policy meant the BOJ’s buying has been most concentrated in 10-year bonds or shorter, making supply-demand conditions tight, so market participants and analysts speculate that’s where it could reduce purchases the most.

But the preferred shape of the curve depends on the types of investors. For example, mega banks want a sharper curve as they borrow short-term and lend long-term.

(USD 1=153.72 yen)

(Reporting by Brigid Riley; Editing by Vidya Ranganathan and Sam Holmes)