US Treasury yields fell again as investors appear more inclined to believe that there will be no further interest rate hikes in the coming months, following the latest policy-setting meeting by the Federal Reserve. As widely anticipated, the central bank kept its benchmark fed funds rate range at 5.25%-5.50% on Wednesday, in alignment with the ECB's recent stance. While Fed Chair Jerome Powell retained the possibility of another rate hike, his remarks indicated a lack of firm commitment to this idea. Investors are now looking to when the easing cycles start and how far they go. Fed funds futures for December 2024 are currently priced at a 4.43% rate.
That said, even if the cycle of interest rate hikes has come to an end, it does not necessarily mean that the central bank will make its monetary policy less restrictive. The Federal Reserve continued to reduce the size of its balance sheet in October, by nearly $95 billion, at $7.87 trillion for the first time since May 2021, down by 1 trillion compared with its peak reached in April 2022 right before the runoff.
The question now is whether the Federal Reserve can maintain this pace against a backdrop of geopolitical tensions, growing U.S. government deficit, and reduced foreign appetite for U.S. debt. The financing needs of the federal government are growing at a time when China and Japan, historically major U.S. Treasury holders, have seen their holdings drop to 15-year lows. On the one hand, China may no longer see the need for a large stockpile of dollars amid economic, political, and military rivalry between both countries. On the other hand, Japan must tap its foreign reserves to support the yen which recently plunged to a 33-year low against the greenback.
The yield on the 10-year Treasury yield lost 27 basis points from 4.84% to 4.57% while the 2-year yield was down 17 basis points from 5.01% to 4.84%.
In Europe, the 10-year German bund yield fell about 18 basis points from 2.83% to 2.65%. Similarly, the yield on the French 10-year OAT eased 22 basis points from 3.46% to 3.24%. Eurozone inflation dropped to a two-year low in October.
The riskiest bond segments witnessed sizable weekly gains, fuelled by renewed hopes that an era of unprecedented monetary tightening may be coming to an end in the wake of the major central banks' decisions to leave interest rates unchanged.
The IBOXX € Liquid Corporates gained 1.26% for the week. In the U.S., the IBOXX $ Domestic Corporates index was up 1.31%. High yield bonds followed suit, with a gain of 1.22% in Europe (IBOXX € Liquid High Yield Index) and a jump of 3.09% in the U.S. (Markit iBoxx USD Liquid High Yield Capped Index). Lastly, emerging debt in local currencies was up 1.78% as the dollar slipped against most currencies. The dollar index, a gauge of the greenback's value against six major currencies, dropped 1.42% for the week to 105.07. The GBPUSD pair gained 2.15% while the EURUSD pair added 1.60%.