What’s driving bonds

Many things, not the least of which is that they overshot to the downside (yields higher) as the market panicked about everything from treasury issuance (too much) to a higher r* (natural rate of interest).

The market has somewhat retraced those fears, and hence the quantum of overshoot has come down (yields lower).

In addition is the increased belief that the Fed is done, mainly because inflation has been behaving. There was a couple prints there for a while which made it look like inflation could be accelerating, but then didn’t, and subsequently resumed its polite downward trend.

And that leads to the below comment from Fed Governer Waller, in which he reminds everyone of the Taylor rule (framework used to set policy). Note the bit in the red box “you don’t have to keep rates at these levels”.

He is very much opening the door to rate cuts by March.

Now this is the whole soft landing conversation, writ large, but this time, instead of you and me (market participants, e.g. fund managers, advisors, traders) it is a Fed governor moving towards the markets’ narrative.

We already know pictorially what this looks like, I tend to produce the below graphs at nearly every investment committee.

If inflation comes down to target…

…the cash rate (stance of policy) can be relaxed, potentially by 150bps or so.

That would create a strong bid for bonds, in all likelihood.

Now Waller could be wrong, we’ve been head-faked multiple times, 2024 might not prove to be the year of the very first ever soft landing, and we’d be better off in gold, cash, the USD, and maybe some real assets (not infrastructure or property) like commodities and alternatives.

But so far, so good.

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