Catch the cresting wave?
After numerous bruising false starts, there’s now a dash to lock onto what are still some of the highest government and corporate bond yields in 15 years before they evaporate as central bank easing finally gets underway in earnest.
Emboldened by headline inflation back at target and likely tax rises from the new British government, the Bank of England narrowly voted for its first interest rate cut in four years this week. That cut came within 24 hours of the U.S. Federal Reserve signaling it was ready to likewise cut rates in seven weeks time.
Although laced with “softly softly” rhetoric and caution about “data dependency,” these two are merely catching up on the start already made by the central banks in the euro zone, Switzerland, Sweden and Canada.
And with real inflation-adjusted policy rates rising sharply to their tightest levels since the global banking crash of 2008, labor markets loosening and manufacturing growth stalling, there appears to be a consensus that now is the time to move to ensure they are not scrambling later on if the economic slowdown snowballs.
Short-dated government bonds are leading the charge.
Two-year U.S. Treasury yields have clocked a cumulative 50-basis-point (bp) swoon in the space of a month to hit their lowest levels since February. Two-year UK gilt yields have shed as much in that time to plumb their lowest levels in more than year.
But it occurred across the curve - with 10-year Treasuries losing their 4% handle for the first time in six months. Europe rallied in sympathy, with even recently edgy French 10-year government yields falling back below 3% for the first time since a contentious snap election was called there in June.
And the widest sweep of global bond markets at large - the Bloomberg Multiverse index of government and corporate bonds - has seen implied yields plummet through 4% again to their lowest levels since early February.
LEAK OUT THE CURVE
There have been false dawns before of course.
The combination of creeping industrial slowdowns and better-behaved inflation, and wariness of many pricey equity markets, means still-brimming coffers of cautious cash may now start to leak out as short-term money market rates tumble.
The rush to secure a longer period of fixed returns in bonds while yields there are still historically high seems a likely first port of call.
And there’s still a lot of money in cash.
According to ICI data, total assets in U.S. money market funds rose to the highest level on record this week at some $6.14 trillion - almost $1.6 trillion more than was there before the Fed started lifting rates in March 2022.
The question is whether it’s now worth shifting to what are now much lower longer-term yields.
Anticipating a Fed move from its 5.38% policy mid-rate in September, three-month Treasury bill rates have slipped 10 bp over the month to 5.28% - but they remain 110 bp above fast disappearing two-year yield at 4.2%.
And yet futures markets already price a likely series of Fed cuts ahead that would bring policy rates below the current two-year Treasury by March of next year - and two-year notes themselves would almost certainly be far lower by then if that scenario unfolded.
All things equal, the current rates universe suggests a new two-year note bought today would yield more than a 3-month T-bill for 18 months of its maturity.
Analysts at TS Lombard earlier this year calculated that current two-year yields are still attractive even if you assume the 200 bp of Fed easing in this cycle now priced by futures markets “normalizes” the yield curve and returns a premium on two-year yields over Fed policy rates to a 50-year average of 30 bp.
And even if you think 200 bp sounds like a lot of easing, bear in mind that would still leave Fed policy rates at twice the 20-year average and almost 60 bp above what Fed policymakers see as long-term neutral - still ‘restrictive’ in the parlance of the U.S. central bank.
The upshot is that the temptation to move cash holdings further out the curve may now prove irresistible and bond markets seem to see that wave coming at last.
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