Above: File image of Jerome Powell. Source: Federal Reserve.
The rally in bonds that has powered the U.S. Dollar higher can continue according to fixed income strategists at Bank of America.
According to rates strategist Mark Cabana, the rise in longer-dated bond yields is down to investors slashing their expectations for rate cuts at the U.S. Federal Reserve in 2024, and the conditions to halt the move are not yet in place.
"U.S. rates have risen sharply due to: (1) resilient U.S. data (2) daunting supply / demand backdrop (3) stretched UST positioning. All of this has led to 75bp of 2024 cuts instead of 150bp in July," says Cabana in a note to clients.
The rise in longer-dated bond yields has stolen the show in global financial markets over the course of the past week as fresh post-2007 highs have been printed, leading to declines in stock markets and a rise in the U.S. Dollar.
"The recent sell-off was catalyzed by the September FOMC. Powell likely is not confident that rates are sufficiently restrictive; likely higher U.S. rates till they bite," says Cabana.
Above: U.S. ten-year bond yields (top pane) are at their highest levels since 2007, and the USD is responding by going higher.
The Federal Reserve on September 20 successfully managed to convince markets the odds for rate cuts in 2024 were far lower than the consensus expected, with Fed Chair Jerome Powell suggesting he does not yet seem confident rates are sufficiently restrictive.
"Insufficiently restrictive policy suggests higher rates as the market continues to reduce cutting expectations for 2024-26," says Cabana.
Bank of America analysts expect U.S. rates to keep rising until negative feedback from either of the following emerges:
(1) real economic slowdown
(2) risk assets, or
(3) enough cuts are priced out - which would also contain the sell-off.
"Our bottom line: the path of least resistance is higher rates and steeper curve," says Cabana.