Recalibrating Expectations

In the world of trading, bond yields took a dip on Thursday, with the main focus being the recalibration of expected Federal Reserve interest rate cuts. This shift in expectations has caught the attention of traders.

Yield Movements

Here are the key yield movements observed:

  • The yield on the 2-year Treasury BX:TMUBMUSD02Y dropped by 3.4 basis points to 4.329%.
  • The yield on the 10-year Treasury BX:TMUBMUSD10Y fell by 3 basis points to 4.079%.
  • The yield on the 30-year Treasury BX:TMUBMUSD30Y eased by 1.7 basis points to 4.301%.

Market Drivers

Recent robust U.S. economic data, including an unexpectedly strong retail sales report, have caused a stir. Alongside this, Federal Reserve officials have made concerted efforts to push back against rate-cut expectations. These factors contributed to seeing the 10-year Treasury yields rise above 4.1% earlier this week.

However, some of these gains have been reversed as we approach important U.S. economic updates, such as the weekly initial jobless benefit claims, the January Philadelphia Fed manufacturing survey, and housing starts and building permits for December.

Fed Officials' Remarks

Noteworthy remarks by Fed officials on Thursday include Atlanta Fed President Raphael Bostic speaking on the economic outlook at 7:30 a.m. and again at 11:30 a.m.

Yield Changes

The benchmark yield had dropped to as low as 3.8% shortly after Christmas. At that time, investors were hopeful that falling inflation would pave the way for the central bank to implement substantial borrowing cost reductions of up to 150 basis points throughout the year, starting in March.

Market Expectations for Fed Interest Rates

Now, markets are pricing in a 97.4% probability that the Fed will leave interest rates unchanged at a range of 5.25% to 5.50% after its next meeting on January 31st, according to the CME FedWatch tool.

Potential Rate Cut in March

However, the chances of at least a 25 basis point rate cut by the subsequent meeting in March is priced at 63%, down from 73.2% a week ago.

Long-term Fed Funds Rate Target

Despite the current expectations, the central bank is still anticipated to take its Fed funds rate target back down to around 3.98% by December 2024, according to 30-day Fed Funds futures.

U.S. Treasury Auctions

In other news, the U.S. Treasury will auction $18 billion of 10-year TIPS, or inflation-protected securities, at 1 p.m.

Expert Opinions

"The big question for markets at the moment is whether 2024 to date is just an understandable hangover to an exceptionally good end to 2023 or a marker for a more challenging year ahead," said Jim Reid, strategist at Deutsche Bank.

"We have corrected back a bit this week after a slew of relatively 'hawkish' central bank speak (vs. market expectations), and yesterday's surprisingly strong U.S. retail sales, but it still feels optimistic to assume such levels of cuts without economic troubles," Reid added.

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