Market expectations for the Federal Reserve’s interest rate cuts this year have been significantly reduced, and US bond prices have plummeted to a six-month low. UBS analysts have warned that if the US economy remains resilient and inflation remains stubborn, the Fed may resume raising interest rates next year, with rates potentially rising as high as 6.5%.
Last week, the US released its March Consumer Price Index (CPI), which showed a year-on-year increase of 3.5%, higher than expected. Retail sales for March also grew by 0.7% compared to February, surpassing market expectations. These strong economic indicators, along with sustained fiscal spending and persistent inflationary pressures, have pushed the yield on US 10-year Treasury bonds to 4.63%, reaching a new high since mid-November last year.
At the same time, US bond ETFs have experienced significant declines. iShares 7-10 Year Treasury Bond ETF has dropped to its lowest level since November 13, 2023, falling 5.6% from its peak in February 2024. iShares 20+ Year Treasury Bond ETF has also experienced a decline of over 11% from its peak in January.
UBS is concerned about the Fed’s continued interest rate hikes. Currently, the Fed’s interest rates are maintained at a high level of 5.25% to 5.5%. Initially, the market expected the Fed to cut rates in June and three times throughout the year, but now confidence in rate cuts has been greatly diminished. UBS strategists have warned that the data instead increases the possibility of the Fed raising interest rates instead of cutting them, with rates potentially reaching as high as 6.5% next year.
UBS originally anticipated two rate cuts by the Fed this year. However, they now believe that the likelihood of inflation reaching the Fed’s target is increasing, which will prompt the Fed to raise rates again and trigger a significant sell-off in the stock and bond markets. UBS has lowered its expectation for rate cuts this year from 275 basis points to only 50 basis points. They warn that if the economy does not land softly and further rate hikes are triggered, the US bond yield curve will flatten, benchmark yields will increase significantly, and the stock market could plunge by 10% to 15%.
Meanwhile, according to The Wall Street Journal, the US recently auctioned $39 billion worth of 10-year Treasury notes, but demand was weak. The higher-than-expected inflation data released last week has resulted in heavy selling pressure in the bond market over the past week, and the results of the auction for 3-year and 30-year Treasury bonds reflected a lack of interest from investors. Analysts are concerned that the oversupply of US bonds will impact other parts of the financial market, push up the government’s borrowing costs, and harm the economy.
Since the outbreak of the pandemic, the issuance of US bonds has seen explosive growth. In the first three months of this year, the US sold $7.2 trillion worth of bonds, reaching a record high for a single quarter. According to estimates from the Congressional Budget Office, the amount of bond issuance over the next ten years will increase from $28 trillion to $48 trillion, far exceeding the $13 trillion from ten years ago.