U.S. Treasury bonds saw a strong surge on Thursday, benefiting from the latest data reflecting a slowdown in economic activity and reduced inflationary pressures, which quickly boosted market expectations for a Federal Reserve interest rate cut within the year.
In April, U.S. producer prices recorded their largest drop in five years unexpectedly, and retail sales significantly slowed down, reflecting the response of businesses and consumers to potential tariff increases. The data indicated that businesses may have started to internally absorb the rising cost pressures, while consumers reduced consumption of imported goods. Market participants generally view such "bad news" as favorable for the bond market.
The bond market reacted swiftly and dramatically: the two-year Treasury yield fell by 10 basis points to 3.95%; the yield on the 10-year Treasury, closely tied to Fed policy expectations, also declined to 4.43%; although the drop in the 30-year Treasury yield was smaller, the overall yield curve saw a significant decrease.
Swap contracts indicate that traders now fully factor in the possibility of a Fed rate cut starting in October, with strong bets on a September cut as well, expecting a total rate reduction of about 55 basis points for the year. This timeline is earlier than some Wall Street institutions, despite recent upgrades in yield forecasts by institutions like JPMorgan, TD Securities, and Bank of America, citing expectations of prolonged high interest rates by the Fed.
Meanwhile, the U.S. dollar exchange rate fell amid the bond rally. Investor concerns about the U.S.'s long-term fiscal situation have also grown, especially with the backdrop of Republican lawmakers pushing for a new tax cut bill, which is seen as potentially expanding deficits and exacerbating debt burdens.
JPMorgan CEO Jamie Dimon warned that the U.S.'s fiscal deficit and total debt levels are "worrisome" and may contribute to future inflation and long-term interest rate increases, even raising the risk of stagflation. He noted at JPMorgan's annual global markets conference in Paris that in the long run, this would pressure economic growth.
According to data from the Peterson Foundation, at least $9.3 trillion of the U.S. federal debt will mature and need refinancing within the next year, with an additional $2 trillion in new debt needed to fill budget deficits. As the Treasury continues to increase short-term Treasury bill issuance, pressure on short-term yields will also challenge fiscal sustainability.
Nevertheless, market confidence in the Federal Reserve maintaining interest rates in the short term remains steady. The Fed's recent meetings have kept policy rates unchanged, stating that decisions will be made after obtaining more clear information on economic trends. Cumberland Advisors Chief U.S. Economist David Berson noted that if the trends of weak consumption and slowing inflation persist, the Fed will have more room to modestly loosen monetary policy within the year.
It is noteworthy that Fed Chair Jerome Powell did not comment on the direction of recent monetary policy in his Thursday speech on evaluating the policy framework, leaving the market to rely more on economic data for judgment.
