Rates on U.S. government debt fell for the fourth straight session on Tuesday, fueled by evidence of slowing economic activity that could take the edge off of inflation.
For much of 2024, such a view would have been treated as good news because of the pressure it takes off of the Federal Reserve to keep interest rates at the highest levels in 23 years.
Instead, a subtle shift appears to be unfolding now in the bond market, in which the question is whether the central bank may need to cut borrowing costs to help prop up the economy.
That’s a turnaround from the view held just a week ago, when Treasury yields were rising by enough to rattle the stock market due to the possibility that many more months of positive inflation data would be needed for policy makers to cut the Fed’s benchmark interest-rate target from its current range of 5.25% to 5.5%.
“The market is starting to lean back toward the idea of the Federal Reserve starting to cut sooner than later,” said John Farawell, executive vice president and head of municipal trading at New York-based bond underwriter Roosevelt & Cross. “It’s like we are getting kind of a soft landing, but we are back at a point where the Fed might need to help the economy.”
Fresh economic data released on Monday and Tuesday have underscored this point. On Monday, the Institute for Supply Management’s manufacturing purchasing managers’ index came in at 48.7% for May, below the median forecast of 49.6%, on stalling activity. Then on Tuesday came the news that U.S. job openings fell to 8.1 million for April, also below economists’ expectations, in a sign of a cooling labor market.
Though the data isn’t definitive enough to indicate that a recession might be on the way, Tuesday brought a renewed sense in the bond market that any economic slowdown might be serious enough to requiring rate-cutting action by the Fed in a matter of months. Fed-funds futures traders pushed up the likelihood of at least a quarter-point rate cut by September, to 65.7% versus 59.6% a day earlier, according to the CME FedWatch Tool. Meanwhile, swaps were pricing in higher odds of rate cuts beginning in November, Bloomberg News reported.
“The decline in yields over the past few trading sessions is in response to a string of data that suggests the economy is indeed cooling,” said Chip Hughey, the Virginia-based managing director of fixed income for Truist Advisory Services. “Today, job openings fell to their lowest point in more than three years. That comes on the heels of reported sluggishness in housing, spending and manufacturing activity. It appears the impact of the Fed’s historic tightening cycle is slowly starting to emerge.”
While the Fed will want to see more evidence of sustainable disinflation, “recent economic trends — should they continue — are consistent with the Fed not executing any further rate hikes and instead beginning to lower interest rates later this year,” Hughey wrote in an email. “The retreat in U.S. Treasury yields is a recalibration for the rising probability of this outcome. We continue to expect the Fed to initiate its first rate cut at the September FOMC [Federal Open Market Committee] meeting.”
On Tuesday, 2-year BX:TMUBMUSD02Y, 10-year BX:TMUBMUSD10Y and 30-year Treasury yields BX:TMUBMUSD30Y all closed lower for the fourth consecutive session.
Rates on 10- and 30-year government maturities finished at their lowest levels in two months, at 4.335% and 4.483% respectively. They also had their biggest four-day declines since the period that ended on Feb. 1. The direction of long-dated yields tends to reflect the bond market’s broader view of the economic outlook.
The simultaneous drop in shorter-term rates sends a worrisome message about the shorter term because it indicates the Fed may need to start moving interest rates lower. The policy-sensitive 2-year rate finished at 4.77% and had its largest four-day decline since the period that ended on May 6.