Macro Minute: Week of January 29, 2024

We have all heard the saying “give an inch and they take a mile.”  That is exactly what has happened in the bond market. I went from bearish bond to constructive bonds, but I am now beginning to get more neutral bonds. Let me try and expound on my thinking. The bond market is influenced by numerous things, and I am not egotistical enough to think I know them all. I do think I can gauge the major trends and longer-term drivers.

Let’s start with the supply side. The US government under both parties has shown a propensity to pass budgets that spend more than they receive in taxes. It is pretty safe to assume that will continue regardless of how elections turnout. The only variable appears to be how big the deficits will be. This is important because this spending is financed with federal government debt issuance. This ensures that there will be ample supply of government debt going forward.

The reason I previously went from bearish to constructive last year was three-fold. First, the Federal Reserve started signaling a stance that they would not hold rates as high for as long. Second, the rates had gotten to very high levels. Third, Janet Yellen at the Treasury, changed the composition of the auctions to issue more short-dated bonds where there are more buyers.

These have played out in a short time frame. We are now looking at a situation where the bond market is pricing in seven rate cuts for 2024, beginning in March. Even with a Federal Reserve that is acting less aggressive, this is a lot of cuts priced in.

To sum up my thoughts I’ll say this. Bonds went from cheap to expensive in about four months. While the Federal Reserve may not push back too hard against what has happened, the opportunity does not appear as favorable for bonds at these prices.

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