Funds pouring into safe havens! After half a year, U.S. Treasury yields fall below 4%.
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Driven by credit concerns and trade tensions, the US Treasury market staged a classic safe-haven rally, with the 10-year Treasury yield falling below the 4% mark for the first time since April, while the 2-year yield dropped to its lowest level since 2022.
Last week, credit risks at US regional banks caused market turbulence, prompting investors to flock to Treasuries for safety. The regional bank stock index recorded its largest decline since the market chaos triggered by tariffs in April. The 2-year Treasury yield, sensitive to interest rate policies, fell below 3.4%, while the 10-year yield hit a low of 3.93%.
This was the second wave of safe-haven buying in the Treasury market in October. Earlier this month, renewed trade tensions triggered a larger rally in Treasuries. Meanwhile, the US government shutdown delayed the release of key data such as employment and inflation, increasing market uncertainty.
The market has fully priced in expectations for a 25 basis point Fed rate cut on October 29. Against a backdrop of high equity and credit market valuations, investors are locking in the 4% yield on 10-year Treasuries as a safe allocation.
It is worth noting that this week the US will release the September CPI report, which analysts believe may temporarily prevent further declines in Treasury yields.
Safe-haven qualities reconfirmed
This month’s market action reminds investors that Treasuries still play their traditional role as the ballast of investment portfolios during crises.
This stands in stark contrast to April—at the time, Trump’s tariff policies sparked market turmoil, prompting concerns that global investors might dump Treasuries. During that period, Treasuries fell in tandem with equities and the dollar.
"US Treasuries have performed excellently as a risk-hedging tool over the past week," said Priya Misra, portfolio manager at J.P. Morgan Investment Management. She pointed out that, if more credit concerns or trade tensions arise, "rates could fall further."
Last week’s bond rally was reminiscent of March 2023, during the collapse of Silicon Valley Bank, when the 2-year Treasury yield plunged more than 1 percentage point in a short period. The 10-year Treasury yield has only fallen below 4% a few times since April. Last Friday, the yield dropped to 3.93%, the lowest since April 7.
The future path of Treasuries largely depends on traders' expectations for Fed rate cuts over the next twelve months or so.
According to a previous article by Jiemian, Fed Chair Jerome Powell noted in a speech last week that “the risks of a downside in employment seem to have increased,” hiring is slowing, and jobs may decline further.
At its September meeting, the Fed restarted its easing cycle, cutting rates by 25 basis points to the 4%–4.25% range. Market expectations for the so-called terminal rate in this cycle fell below the recent 3% floor this month and are approaching the cycle low for September 2024.
Currently, there is broad market expectation of a 25 basis point rate cut in October, and after the October 29 meeting, the market expects another 25 basis point cut in December, with possibly two more cuts before mid-2026.
Bloomberg strategist Alyce Andres commented, “Until some unknowns—government shutdown, credit market conditions, tariffs—become clear, the 10-year Treasury yield is unlikely to move far from 4%.”
Is there still room for Treasury yields to fall?
Despite concerns over currency devaluation trades spurred by large borrowing needs in major global economies, pushing gold to a record high above $4,000 an ounce, even 30-year Treasuries have risen along with gold prices.
Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities, said, the 10-year Treasury yield “has room to fall below 4%, but conditions need to worsen significantly from here.”
Traders are using options to hedge against the risk that the 10-year yield falls sharply below 4%, and deeper declines could accelerate the rally by triggering further hedging. This could make this year the best for Treasuries since 2020. The Bloomberg Treasury Index was up 6.6% through last Thursday this year.
Morgan Stanley’s head of rates strategy, Matthew Hornbach, and his colleagues believe there is further downside for the 10-year yield. In a previous report, they wrote:
Investors should gladly bid farewell to the era of 10-year Treasury yields above 4%, partly because the longer the government shutdown lasts, the more serious related concerns may become.
However, a set of key government data is due this week. The September Consumer Price Index (CPI), originally scheduled for release on October 15, will be released on Friday. Economists expect the core CPI to be flat month-on-month, while the headline CPI is 3.1% year-on-year, well above the Fed’s 2% inflation target.
In an email, Hornbach stated, investor concerns over this data “may temporarily prevent the 10-year Treasury yield from falling too far below 4%.”
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