Bonds May Be Carving Out Important Lows

U.S. Treasury notes and bonds are holding near their lowest levels of 2024

• Rate cut odds for 2024 have been decimated, with the odds of a 25-bps rate cut in March a mere 10.5%.
• Only three cuts are fully discounted, with a 62.3% chance of a fourth cut by December.
• Bond volatility has not risen in recent days despite the choppy trading conditions.

The January U.S. inflation report may have shaken up bond markets (for a short-sighted reason, mind you), but there are signs that the decline in recent weeks may be coming to an end.

What has driven the shift in bond yields in 2024? Receding Fed rate-cut odds.

Coming into 2024, there were six full cuts priced-in, with an outside shot at seven cuts this year. Since the start of the year, Fed rate cut odds have been decimated. Ahead of the January FOMC meeting, there was north of a 94% chance of a 25-hasis-point (bps) rate cut in March. Those odds are sitting at a lowly 10.5% now. But it’s not just March.

Rate-cut odds down considerably

Fed rate cut odds have been squashed across the board. With respect to current market pricing, the odds of a rate cut in the first half of 2024 are now 78.3%. Why does this matter? Because of the relationship between cut odds and bond prices in recent weeks: using either Fed funds futures (/ZQ) or three-month SOFR (/SR3), bonds across the curve (from 2s (/ZTH4) to 30s (/ZBH4)) have at least a +0.74 rolling one-month correlation with cut odds.

A bet against bond at these levels, for continued directional weakness, is a bet that the Federal Reserve will not cut rates in the first half of 2024.

Swing lows established this week across the curve may prove to be an important technical turning point. That’s not to say that there will be a significant rally here henceforth–the continued upward momentum by U.S. equity markets offers more allure for traders. Why would someone allocate to fixed income when stocks are still climbing?

As noted last week, “amid a lackluster volatility environment, potential downside breaks in 10s (/ZNH4) and 30s (/ZBH4) can’t be ignored, nor should they necessarily be faded right away. Support may be nearby, but some more choppiness in bond markets may be necessary before bottoming occurs.”

This remains the case, but the charts are starting to shape up in a more constructive manner that may soon yield better opportunities on the long side.

/ZN U.S. 10-year note price technical analysis: daily chart (September 2023 to February 2024)

Last week it was noted that “a break of the current support zone opens the door for a deeper setback towards the late-November swing low/mid-November swing high near 109’20.” Indeed, the U.S. 10-year Treasury note (/ZNH4) hit a low of 109’16. Technically, if there were a place for a near-term low, this would be juncture.

That said, momentum remains weak. /ZNH4 is still below its daily 5-, 13-, and 21-day EMA envelope (which is in bearish sequential order), Slow Stochastics are holding in oversold territory (but beginning to trend higher), and MACD is still trending lower through its signal line.

The continued lack of volatility (IV index: 6.5%; IV rank: 8.6) further underscores why bulls need to remain patient and let the charts unfold; there is little rhyme or reason to begin trying to collecting premium right now via put spreads or even taking a directionally bullish bet via call spreads. A close back above the daily 5-EMA (one-week moving average), which hasn’t happened since February 2, is necessary before long delta positions should be considered.

/ZB US 30-year bond price technical analysis: daily chart (September 2023 to February 2024)

Similarly, in our prior bond outlook we noted that “[the U.S. Treasury 30-year bond,] /ZBH4 is now gearing up for another retest of support in the area around 118’09/28, which proved pivotal at the end of November 2023, beginning of December 2023, and end of January 2024.”

Thus far, this area has held as support. Momentum is weak here as well, and the daily 5-EMA remains an important trigger point. The lack of volatility in /ZBH4 (IV Index: 13%; IV Rank: 19.1) means bond bulls may want more technical development before initiating position–but that time may soon be approaching.

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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