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Written by: Steve Majoris | Advisor Asset Management
It wasn’t long ago when almost all U.S. nominal Treasury rates were at or above 5%. Higher-for-longer was the concern for fixed income investors, many of which saw money markets as the best option for safe, stable interest income with nothing to worry about. Fixed income markets have been volatile and tough to interpret for many investors so far this year, with some perhaps wondering whether the higher-for-longer interest rate cycle is soon coming to an end. A year-to-date chart of the 10-year Treasury note looks more like a roller coaster than a benchmark interest rate, but as of late things have become a little simpler — in the sense that Fed rate cuts are likely coming soon. Yields have moved lower over the past month in response to such hopes. Through July 30 the 2-year, 10-year and 30-year bonds are down approximately 40bps (basis points), 30bps and 20bps, respectively. Month-to-date returns for fixed income markets are in the green big, some areas with the best monthly numbers of the year and back in positive territory for 2024.
Now, the market seems to be working under the assumption that inflation will continue to trend lower toward the Fed’s 2% target and are now looking past inflation concerns from the past, especially when looking at the 2-year Treasury, which is down almost 80bps over the last 30 trading days. Treasury market breakeven rates (inflation expectations) across the board are now closer to 2% with the 2-year Treasury breakeven rate recently touching as low as 1.76%. Fed Chair Powell mentioned at last week’s press conference that rate cuts could come as soon as the September meeting, while Fed Funds futures contracts are also pricing in the first cut in September as well as three cuts by year end. I’m not a gambling man, but it looks like a September rate cut is a lock, especially when you factor in Powell’s concern over certain areas of the economy, stating, “The economic outlook is uncertain, and the committee is attentive to the risks to both sides of its dual mandate.” Powell seems to be a little more anxious of a deteriorating economic backdrop and seems to have sharpened focus on the employment side of the mandate.
The month of July has had a negative tilt with economic data that could be hinting at a potential slowdown. Last week we saw further “soft” economic data with the ADP Employment Change missing to the downside, a soft Dallas Fed Manufacturing Activity survey, initial jobless claims continuing to trend higher and an ISM Manufacturing miss which saw notable declines in new orders and employment. The week ended with Friday’s Nonfarm Payrolls number coming in below expectations and showing a meaningful uptick in the unemployment rate to 4.3%, the highest level since late 2021. On the consumer front, auto delinquencies are on the rise, credit card balances past due hit the highest level since 2012, according to the Federal Reserve Bank of Philadelphia, and many CEOs have mentioned more conservative spending from the consumer in Q2 earnings reports. Recent numbers, as well as Fed Chair Powell comments, have pushed the 10-year below 4.00% — a level not seen since February. In addition to absolute yields moving lower, the change in the slope of the yield curve may be signaling cuts as well. Since late June, 10-year minus 2-year moved from -49bps to -20bps, and 30-year minus 5-year moved from 10bps to 36bps. This sort of yield curve recalibration is typical prior to a Fed easing cycle as we’ve seen prior to 2000 and to 2007.
For those who have been on the fence about whether to sit in a money market or get invested in the markets, the last month may serve as a bit of a wakeup call, in our opinion. Yields can come and go in a hurry. It was less than a year ago when the 10-year Treasury was above 5% and less than four months since the 2-year was above it as well. Friday’s jobs report may have taken 4% yields off the table for good with the 2-year moving to 3.90% after the release. The 3-month T-bill — a proxy for money market rates — is moving lower and most likely signaling that the best days are behind us for these types of cash management vehicles. The average money market fund yield peaked last October at 5.40%, but is now closer to 5.20%. Since the Fed began hiking rates, the amount in money market funds has skyrocketed, totaling over $6 trillion at the end Q2; quite the difference compared to 2021 when the total was less than $500 billion.
It seems that we may be at a bit of an inflection point, one which may warrant putting money to work and one that has the potential to bring about some big moves to markets. Even with the recent move lower in yields, we believe that investors should act sooner rather than later to build a fixed income portfolio before current opportunities potentially dissipate. If nothing else, the last month has proven that time IN the market should be more of a focus than timING the market.