Bonds Will Trade Higher in 2024

U.S. Treasury bonds staged a sharp turnaround in Q4 ’23 that sets the stage for a promising 2024. With rate cuts scheduled, will bonds trade higher in 2024?

• U.S. Treasury bonds staged a sharp turnaround in Q4 ’23 that sets the stage for a promising 2024.
• Rate cut odds for 2024 have risen continuously ahead of the new year, with nearly six 25-bps rate cuts discounted.
• Bond volatility continues to contract but is still appearing at the long end of the curve.

No more rate hikes are expected from the Federal Reserve, and it is likely to lower the rates in 2024 well before the next presidential election. The U.S. economy is losing momentum; it is unclear if this will lead to a recession or just a slower pace of growth (as of Dec. 22, the evidence suggested the latter, at least for the early part of 2024).

In any case, this implies one thing: U.S. Treasury bonds have reached their lowest point of the cycle, and falling growth and inflation prospects should drive down yields further in 2024.

CME FedWatch: 2024 Fed interest rate cut/hike odds

Why it makes sense to expect Fed rate cuts

Progress on inflation looks set to continue through early 2024, particularly as base effects in the data series cater to a tailwind for disinflationary impulses.

Headline CPI may post a sub-3% reading before the first quarter of 2024 concludes, setting up the Fed’s first rate cut in March 2024. While that seems premature to some, it does comport with history. The average time between the Fed’s final hike and first cut is eight months and March 2024 is eight months after the final hike in July 2023.

Moreover, inaction by the Federal Open Market Committee would be a de facto policy tightening in an environment where inflation is falling. If the nominal overnight fed funds rate is 5.5% and inflation is 4%, then the real rate is 1.5%. With inflation now down to 3% while fed funds are unchanged at 5.5%, that means the real rate is closer to 2.5%.

A higher real fed funds rate will crimp economic growth, threatening the resiliency of the labor market and undercutting the likelihood of a "soft landing." We define soft landing as inflation moving back to the Fed’s 2% target, the unemployment rate (U3) holding below 4.5%, and U.S. gross domestic product slowing but staying positive. Thus, as inflation comes down, the Fed must start cutting its nominal overnight fed funds rate to prevent overtightening and threatening the soft landing.

Strategic implications

In contrast to 2023, when bond market volatility was high throughout the year across the entire curve, the changing economic conditions indicate that bond market volatility should gradually decline further in the next few months. If at any point during the year yields move higher and bond volatility increases with them, don’t be fooled by the apparent change in trend. Ignore it and take the opportunity to sell bond volatility whenever possible.

/10Y U.S. 10-year note yield technical analysis: daily chart (May to December 2023)

The outlook on U.S. Treasury yields is not based solely on fundamental predictions.

Look at the U.S. Treasury 10-year yield chart. In the last quarter of 2023, it dropped below the ascending trendline from the May, July, and September low points, and below the neckline of the head-and-shoulders pattern at 4.472%. Technically, charts have changed direction indicating that yields have peaked/prices have bottomed, a trend that should persist throughout 2024.

Tickers to Watch: /ZN, /ZB

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Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multinational firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx

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