The Bond Market Climbs as Signs of US Slowdown Fuel Fed Bets

The world's largest bond market experienced an upswing following recent economic reports, which intensified speculation that the Federal Reserve might cut interest rates this year to avert a significant slowdown in the US economy.

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Treasuries saw gains across the board as data indicated a rise in recurring jobless benefits applications, hitting their highest level since the end of 2021. Additionally, orders for business equipment from factories unexpectedly fell, and an index of pending home sales dropped to its lowest on record due to elevated mortgage rates and high prices discouraging potential buyers.

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"Continuing claims have increased, reaching their highest level since late 2021, signaling that the labor market may be softening," commented Jeff Roach of LPL Financial. "We anticipate both consumer and business activities to slow in the latter half of 2024, providing the Fed with ample opportunity to begin cutting rates later this year."

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The yield on the 10-year Treasury note fell by four basis points to 4.28%, ahead of a $44 billion sale of seven-year notes and the release of the Federal Reserve’s preferred inflation gauge.

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The S&P 500 hovered around 5,480, with mixed performances among mega-cap stocks. Amazon.com Inc. saw gains, while Nvidia Corp. experienced losses. Micron Technology Inc. dropped significantly as its forecast failed to meet high expectations. Walgreens Boots Alliance Inc. plummeted about 25% after cutting its guidance due to a deteriorating retail environment.

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Traders in the swaps market are pricing in about 45 basis points of easing in 2024, translating to fewer than two rate cuts.

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Fed Bank of Atlanta President Raphael Bostic maintained his expectation of one rate reduction this year in the fourth quarter, amid signs that inflation continues to decline.

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Friday’s personal consumption expenditures (PCE) price data is anticipated to be the slowest of the year, which is favorable news for Fed officials, according to Stuart Paul at Bloomberg Economics.

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"However, with bottom-up analysis indicating that disinflation may stall in the coming months, more significant cooling in the labor market will be necessary for the Fed to start cutting rates," Paul noted. "With consumers showing more restraint amid rising unemployment, we believe there is still potential for two rate cuts this year."

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Concerns about the labor market's strength and its impact on consumer spending, along with the market's heavy reliance on a few key stocks, have led to warnings that the bull market may need a pause, recalibration, and possibly assistance from the Fed, according to Quincy Krosby of LPL Financial.

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Krosby noted that disappointing PCE data could trigger stagflation headlines, while estimates that hold or show cooler data could help the market transition smoothly into July.

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"An overbought and relatively expensive market based on a few mega names may need to recalibrate, allowing other sectors to co-exist or even lead the market," Krosby said. "Such adjustments could cause pockets of volatility alongside attractive opportunities."

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Alejandra Grindal at Ned Davis Research expressed confidence in continued economic expansion into the second half of the year, with low recession risk supporting the current cyclical bull market in equities. However, she cautioned that momentum might stabilize or ease slightly due to peaking global aggregate data, diminishing economic surprises, and rising risks in large economies.

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In a month where Nvidia Corp. briefly became the world's largest company, hedge funds were "aggressively" selling tech stocks, according to analysis from Goldman Sachs Group Inc.

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Goldman's prime brokerage data indicated that this month’s net selling in the US tech sector could be the largest on record since 2017. This reduction in exposure contrasts sharply with last week's record inflows into tech-related funds.

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Investors witnessed a dramatic drop in Nvidia shares, which fell 13% in three days, erasing $430 billion in market value. Although Nvidia's shares rebounded, recouping about half of the losses, they fell again after results from Micron Technology Inc.

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Chris Senyek of Wolfe Research predicts that volatility will likely increase, generally benefiting the "Magnificent Seven" megacaps and the overall momentum trade in the coming weeks. He expects these trends to thrive in an environment where growth is slowing but the Fed is anticipated to begin a significant rate-cutting cycle.

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Commodity trading advisors (CTAs) using trend-following strategies have increased their exposure to Nasdaq 100 futures to stretched levels, making stop-loss triggers very tight. According to Bank of America Corp., CTAs could start unwinding their positions if futures drop by 2.8% or more, a pain threshold that was near 4% just a month ago.

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