After the end of the Martin Luther King Jr. Memorial Day holiday, the US stock and bond markets had a bad start at the beginning of the week, reversing the bullish tone at the end of last week. With Federal Reserve Director Waller's latest speech hitting market expectations for the Fed's aggressive interest rate cut this year, investors in the stock and bond markets seem to have returned to the difficult situation of the first week of the new year.
Market data shows that the yield on US Treasury bonds of various maturities generally surged overnight, and the benchmark 10-year yield has returned to above the 4% mark. The cautious sentiment heightened, overshadowing the optimistic sentiment of investors that the Federal Reserve had clearly ended interest rate hikes, causing the bond rally at the end of last year to abruptly come to an end. Bond yields are inversely related to prices.
As of the New York session, the 2-year US Treasury yield increased by 8.2 basis points to 4.23%, the 5-year US Treasury yield increased by 10.4 basis points to 3.937%, the 10-year US Treasury yield increased by 12.4 basis points to 4.062%, and the 30-year US Treasury yield increased by 12.4 basis points to 4.298%.
The trend of the US bond market on that day was largely influenced by the speech of Federal Reserve Governor Waller. This former hawkish figure from the Federal Reserve stated on Tuesday that the Fed may cut interest rates this year, but there is no need to act too hastily. During his speech at the Brookings Institution, Waller said, "When the time is ripe to start lowering interest rates, I believe it is possible and necessary to act with caution and in an orderly manner."
Although the Federal Reserve has cut interest rates quickly and significantly in many cycles of the past, Waller said he believes there is "no reason to act quickly or cut rates as quickly as in the past."
Waller pointed out that the current interest rate policy of the Federal Reserve is "appropriate". A healthy economic situation provides flexibility for the Federal Reserve to cut interest rates when inflation rates decline. Otherwise, adjusting according to the inflation rate will result in excessively tight policies. The timing and frequency of future interest rate cuts will depend on new data.
Waller emphasized the annual revision of CPI data by the US government in mid February. He pointed out, "Last year's annual update reversed the earlier data showing lower inflation. I hope the revised data can confirm the progress we have seen, but good policies are based on data rather than hope."
After Waller's speech, the market further believed that Wall Street's previous bet on a significant rate cut by the Federal Reserve was too aggressive.
From the pricing of the interest rate swap market, market traders on Tuesday latest estimated that the probability of the Federal Reserve cutting interest rates in March is 64%, significantly lower than the 73% before Waller's speech.
Traders have also seen a significant decrease in their expectations for the full year interest rate cut in 2024.
Doug Huber, Vice President of Investment Strategy at Wealth Improvement Group, said, "The market's expectations for rate cuts are not the same as those of the Federal Reserve, and may continue to lead to volatility in yields. The question is when and how many rate cuts will ultimately occur... For us, this will create an environment where we expect greater volatility in returns."
Marc Chandler, Chief Market Strategist at Bannockburn Global Forex, pointed out that "(Waller) said there is no reason to act quickly like in the past, and interest rate cuts should be done in an orderly and cautious manner. Waller's speech is important, and he clearly confirms what we already know."
Against the backdrop of overnight gains in US bond yields, US stocks also performed poorly on the first trading day of the week. The three major stock indexes in the United States fell overall on Tuesday, with the S&P 500 index falling 0.4% and the tech focused Nasdaq Composite Index falling 0.2%. The Dow Jones index fell 232 points, a decrease of 0.6%.
In fact, as we mentioned on Monday this week, the two-thirds market capitalization of the S&P 500 index is currently tied to the trend of US Treasury yields - performing better when yields decline, and vice versa, the highest proportion since 2001.
However, the increasingly close correlation between US stocks and bond yields also means to some extent that if US inflation cannot quickly decrease, traders may face big problems. Once bond yields no longer decline, a significant portion of stocks in the market will face significant pressure.
Baird investment strategy analyst Ross Mayfield said, "Of course, the valuation of the US stock market is high, but I believe what happened today is more of a broader market consolidation around the view that investors had been overly optimistic about the Fed's willingness to relax policy."