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Written by; Mary Park Durham and Jordan Jackson
Bond investors have grown accustomed to higher interest rate volatility with October providing another gentle reminder. Since the Fed’s jumbo 50 basis point rate cut in September, U.S. 2-year and 10-year Treasury yield have risen by 54bps and 59bps to 4.15% and 4.29%, respectively. This move is somewhat counterintuitive given yields tend to drift lower during cutting cycles and the yield curve steepens driven by falling short rates, not rising long rates. Moreover, the MOVE Index, which tracks rate volatility, also hit its highest level year-to-date. So, what’s behind the recent rise in rates and volatility?
Key factors to consider include:
- Increased odds of a Republican sweep: Since early September, betting markets have been pricing in a higher probability of a former President Trump victory. While the presidential race remains a close call, a full Republican sweep becomes more likely given the cards are stacked against the Democrats in the Senate and a commanding victory in the electoral college likely tilts the House to swing in favor of a Republican majority. Given this, long-end yields have risen due to expectations of additional tariffs and higher deficits assuming the expiring provisions in the 2017 Tax Cuts and Jobs Act are extended1 under a full Republican government.
- Recession fears easing: Recent data indicate a higher probability of a soft landing. The September payrolls showed a strong 254K payroll increase, reducing labor market slowdown fears. Retail sales also grew a robust 0.4% in September, and 3Q24 GDP increased by 2.8% q/q saar fueled by strong consumer spending.
Taken together, the recent rise in yields has led to modest core bond performance at just 2% year-to-date. However, over a 1-year period, core bonds are up 11%. All things considered, we anticipate the 10-year yield stabilizing between a range of 3.75%-4.25% over the next 12 months as the Fed progresses with its rate cutting cycle and U.S. economic growth moderates. However, fiscal challenges could keep long-term rates elevated, particularly after the election if policy outcomes worsen future deficit projections more than anticipated.
With our base case of a soft landing, short rates are likely to be biased lower given declining policy rates, reducing the appeal of cash-like instruments. Investors should consider intermediate-duration fixed income in quality sectors to lock in attractive yields and prepare for various political and economic scenarios. Shorter term corporate bonds across the credit quality spectrum also look appealing given overall yields, and while spreads remain tight, declining default rates and low near-term recession risk should keep spreads tight for longer.
Average cumulative change in Treasury yields after Fed rate cuts
Average of six rate cutting cycles, 1984-2023
Source: Federal Reserve, J.P. Morgan Asset Management.
(Left): Analysis references data from 1984, 1989, 1995, 2001, 2007 and 2019. *Current cycle reflects change since the Federal Reserve’s 50 bps rate cut on 9/18/2024 (~6 weeks ago).
Data are as of October 30, 2024.