Shorter-dated Treasuries are set to outperform as a swift slowdown in inflation means the Federal Reserve is likely to cut interest rates sooner and deeper than markets had expected, according to Pendal Group Ltd.
(Bloomberg) — Shorter-dated Treasuries are set to outperform as a swift slowdown in inflation means the Federal Reserve is likely to cut interest rates sooner and deeper than markets had expected, according to Pendal Group Ltd.
Two-year Treasury yields can drop to levels near 4% in the medium term, as the Fed may start to loosen policy sooner given that the US inflation eased at a faster-than-expected pace in June, said Amy Xie Patrick, head of income strategies at Pendal in Sydney. The yields on two-year notes fell four basis points to 4.71% on Thursday, adding to their biggest decline since May in the previous session.
“Inflation has been such a big problem for the past year, and we’ve stepped down into a new zip code,” Xie Patrick said. She’s been favoring two-year Treasuries “on the likelihood that the Fed will cut sooner and more aggressively than definitely what they say, but also than what the market currently prices.”
US core inflation slowed to 4.8% last month, the lowest since 2021 and less than economists’ forecast. That set off a strong rally in bonds and a slide in the dollar, as investors unwound bets that the Fed would raise rates again following an expected hike this month.
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Rates traders boosted bets that the Fed pauses after one more hike following the CPI reading, though they don’t expect a cut until May 2024.
Fed Chair Jerome Powell’s favored gauge of inflation — which measures core services excluding rents — slowed to a 1.4% annual pace based on its three-month annualized trend. That underscores the likelihood that this slowdown in price pressures is a sustainable one, Xie Patrick said.
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