Looking back at November, the US Treasury market experienced a significant trend shift: the 10-year Treasury yield, which had been fluctuating sideways in the 4.1% to 4.2% range in the first half of November, declined rapidly in the latter half, even briefly falling below the key 4% level. This change reflects a repricing of global funds' assessment of the US economic outlook and the Federal Reserve's policy path.
Entering December, the Federal Reserve is poised to end its quantitative tightening program, while also planning to release maturing mortgage-backed securities. (MBS) funds are reinvested in short-term Treasury bills. This suggests that the Federal Reserve may return to the market, bringing new incremental demand to the US Treasury market, and the change in market supply and demand balance will also affect the trend of US Treasury yields.
The 10-year US Treasury yield fell below 4%.
In early to mid-November, US Treasury yields generally traded sideways. The 10-year Treasury yield once approached 4.2%, with the market caught in a stalemate between a data vacuum and policy uncertainty. Towards the end of the month, the 10-year Treasury yield fell rapidly, briefly dipping below 4%. Currently, the 10-year Treasury yield is still fluctuating around the 4% mark.
Among these factors, changes in expectations regarding Federal Reserve rate cuts are undoubtedly the core driving force. This is because US Treasury yields are highly sensitive to market interest rates. In its September and October policy meetings this year, the Federal Reserve cut interest rates by 25 basis points twice. Now, with the Fed's final policy meeting of the year approaching, the market is repeatedly debating whether or not to cut rates.
Following the October policy meeting, Federal Reserve Chairman Jerome Powell stated that a December rate cut should not be considered a foregone conclusion. However, with several Fed officials recently making dovish comments supporting a rate cut, expectations have risen sharply. The CME Group's FedWatch tool shows that as of November 30th (Beijing time), the market expects an 86.4% probability of a 25 basis point rate cut by the Fed in December.
Meanwhile, the Federal Reserve is approaching its leadership transition. The prospects for this personnel change are being closely watched by the market. A comprehensive analysis suggests that White House chief economic advisor Hassett is leading the race for the next Fed chair. A representative from the United Credit Ratings Research Center told the Shanghai Securities News that Hassett's stance on monetary policy leans towards dovishness, and if he takes office, he may implement significant interest rate cuts. Under this expectation, the market anticipates a substantial easing of monetary policy in the future, which has also driven the 10-year US Treasury yield below 4% recently.
Marginal weakening of economic data provided fundamental support for the adjustment of US Treasury yields. On November 26th local time, the Federal Reserve's Beige Book showed that most of the twelve Federal Reserve districts reported little change in economic activity, but two districts reported slight declines and one district reported slight growth. While high-end retail spending remained resilient, overall US consumer spending declined further. Some retailers stated that the government shutdown negatively impacted consumer purchasing power. Furthermore, there was widespread upward pressure on costs in the manufacturing and retail sectors, reflecting increased costs due to tariff changes.
According to the Lianhe Credit Rating Research Center, the US labor market is showing signs of weakness, and declining consumer spending and business confidence have exacerbated market concerns about a potential recession. Against the backdrop of increased macroeconomic uncertainty and differing policy paths among Federal Reserve officials, risk aversion has significantly intensified, driving funds into the bond market.
US Treasury yields may fluctuate downwards.
Looking ahead, analysts believe that the trend of US Treasury yields will continue to be influenced by a combination of factors, including monetary policy expectations, economic fundamentals, inflation prospects, and risk aversion.
In the short term, as the market has largely priced in a December rate cut by the Federal Reserve, expectations of a rate cut are likely to continue to dominate the market, keeping US Treasury yields at relatively low levels.
However, looking at past trends, after the Federal Reserve cut interest rates in September and October this year, US Treasury yields did not fall accordingly; instead, they entered a period of fluctuating upward movement. Zhang Juntao, Assistant General Manager and Senior Researcher of the Foreign Exchange and Commodities Department at Industrial Securities Research, told a reporter from the Shanghai Securities News that US Treasury yields often experience a technical rebound, a "sell the fact," after interest rate cuts are implemented.
From the Federal Reserve's perspective, in the absence of key economic data, its guidance on the prospect of interest rate cuts is likely to be cautious. Zhang Juntao further stated that since this policy meeting was held in the absence of key economic data, it is expected that the Fed will be unlikely to release unexpectedly dovish signals, and US Treasury yields may rebound or fluctuate in the short term after the meeting. The Fed still has room to cut interest rates next year. In the medium term, the central level of US Treasury yields will fluctuate downwards.
Changes in the fundamentals of the US economy are also a key factor influencing US Treasury yields. According to the Lianhe Credit Rating Research Center, in the medium term, the interplay between the Federal Reserve's policy shift and economic fundamentals will intensify, potentially increasing the volatility of US Treasury yields, whose trajectory will be highly dependent on the performance of key economic data.
“So far, due to the limited data releases caused by the government shutdown, economic activity data continues to convey a robust impression, but the job market appears slightly weak,” said Wang Xinjie, Chief Investment Strategist at Standard Chartered China Wealth Management. He suggests that investors should rebalance their allocations towards 5- to 7-year bonds, which offer the best balance between yield and fiscal and inflation risks. Overall, the 12-month target range for the 10-year US Treasury yield is maintained at 3.75% to 4.0%, and continued monitoring for any further signs of weakness in the job market is advised.
The yield curve may steepen in the future.
As December approaches, the Federal Reserve is poised to end its quantitative tightening and plans to reinvest maturing MBS funds in short-term Treasury bills.
According to interviewees, this could bring new incremental demand to the US Treasury market. "The Fed's formal end to quantitative tightening means it is expected to shift from net selling to net buying, which will also structurally change the supply and demand in the US Treasury market," said Wang Xinjie. For short-term Treasury bonds, this will provide a new and sustainable source of official demand.
From the supply side, the U.S. Treasury relies more heavily on short-term Treasury bills to meet its financing needs. The Treasury's latest quarterly refinancing plan indicates that it will not increase the issuance of medium- and long-term Treasury bonds for at least the next few quarters and will continue to rely on shorter-term, lower-cost Treasury bills to fill the federal budget deficit.
"Given the still high financing costs, the U.S. Treasury will continue to rely primarily on short-term Treasury bills for financing next year. Currently, the U.S. Treasury has approximately $900 billion in cash reserves, while it typically only needs to maintain around $300 billion. This leaves considerable room for maneuver in financing next year, meaning the U.S. Treasury can reduce its debt issuance by depleting its cash reserves," said Zhang Juntao.
According to the Lianhe Credit Rating Research Center, the Federal Reserve's continued purchases will provide stable demand for short-term U.S. Treasury bonds, helping to absorb the increased short-term bond issuance by the U.S. Treasury.
However, for medium- and long-term US Treasury bonds, issuance pressure remains on the supply side, and demand has not shown significant improvement. The yield curve for US Treasury bonds may steepen in the future. Wang Xinjie stated that since the Federal Reserve's reinvestment is concentrated at the short end, there is no new direct demand support for medium- and long-term Treasury bonds. If the US Treasury maintains or even increases the issuance of medium- and long-term bonds, it will put upward pressure on medium- and long-term US Treasury yields, thereby widening the term spread and steepening the yield curve. However, the price trend of medium- and long-term bonds may also depend more on subsequent economic data and inflation prospects, making the future highly uncertain.
"Overall, the Fed's increased demand will support short-term Treasury yields, while long-term fiscal deficits and rising government debt will put some pressure on long-term yields. This may lead to the Treasury yield curve remaining relatively stable in the short term, but steepening in the medium to long term," said the Lianhe Credit Rating Research Center.
(Source: Shanghai Securities News)
