Major bond-market gauge cements worst 2-day rout since October as market rethinks path of Fed rate cuts

U.S. bonds on Monday extended a rout sparked last week by strong economic data and pushback from the Federal Reserve on the potential timing and magnitude of interest-rate cuts this year.

The benchmark 10-year Treasury yield
rose to 4.163% on Monday, a roughly 30 basis-point jump from the start of February as rates used to finance the economy sharply increased. Bond yields and prices move in the opposite direction.

“The incentives just aren’t there to be in a hurry,” Adam Abbas, head of fixed income at Harris Associates, said of the Fed signaling a slow and patient approach to rate cuts, instead of aggressive cuts envisioned earlier this year by many investors.

Fed Chairman Jerome Powell reiterated a need for the central bank to be careful about rate cuts in a “60 Minutes” interview that aired Sunday. Days before, the Fed kept its policy rate at a 22-year high and Powell said a March rate cut wasn’t likely.

On Monday, a proxy for the broader fixed-income market, the roughly $100 billion iShares Core U.S. Aggregate Bond ETF
fell 0.8%, after slumping 0.9% on Friday. That marked the exchange-traded fund’s worst two-day drop since Oct. 3, 2023, according to Dow Jones Market Data.

Bonds have been prone to explosive volatility in the past few years, and again on Monday appeared to be weigh on the stock market. The Dow Jones Industrial Average
closed 0.7% lower and the S&P 500 index
ended down 0.3% on Monday, but the indexes still were up 1.8% and 3.6%, respectively, on the year.

“It’s a combination of hawkishness from the Fed and strong economic data that’s causing market participants to reassess their outlook for any potential rate cuts this year,” said Sam Millette, director of fixed income for Commonwealth Financial Network, in a call Monday.

Rate cuts still coming

Despite the choppy backup for markets, Robert Pavlik, senior portfolio manager at Dakota Wealth Management, said Friday’s surprisingly strong monthly jobs report and Monday’s service-oriented companies data both bode well for investors.

“It’s not the worst thing in the entire world to have an economy that’s still moving forward,” Pavlik said, adding that sooner or later the Fed will be cutting rates.

“It’s like being told you are going on vacation, just that you need to know how much money you have before you go,” he said.

Even so, gut-wrenching volatility in rates could stick around for the better part of 2024.

The ICE BofA Move Index, a “fear” gauge of bond-market volatility, was last pegged at about 113 on Monday, up from closer to 106 on Friday. It rivaled its highest level in about 15 years at the onset of the pandemic in March 2020, and briefly eclipsed 200 in March 2023, as the collapse of Silicon Valley Bank raised fears of a broader regional-banking crisis.

There also are concerns that higher interest rates for longer could hurt underwater commercial-real estate assets held by banks. The SPDR S&P Regional Banking ETF
fell 1.7% on Monday.

Adjusting to the new normal

Abbas at Harris Associates said 40 to 80 readings for the MOVE index were more typical from roughly 2015 to 2021, and he thinks bond volatility will continue to be an important driver of markets until the Fed provides more transparency on the timing of rate cuts.

However, Michael Miller, president of Wellesley Asset Management who specializes in convertible bonds, said investors shouldn’t hope for interest rates to sink back to artificially low levels seen since the 2007-’08 global financial crisis.

“Having rates around 5% is normal,” Miller said. “Going down to 1% or 2%, those were crisis-level rate declines.” The Miller Convertible Bond Fund MCIFX was up 1.75% on the year through Monday.

The sharp move up in yields has many U.S. bond indexes flipping to negative returns to start 2024, as shares of many large bond exchange-traded funds also have turned negative, according to FactSet.

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