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Treasury Rally Grinding to a Halt

3 April 2019 by Mark Holman

The prospect of slowing global growth, alongside a potential policy error from the Fed and contradictory rhetoric, provided the backdrop for a very tricky 4th quarter for risk assets and a strong rally in US Treasuries. The 10 year moved from 3.24% on November 8th, to close at a yield of 2.68% by year end. Since then however, the market for risk assets has bounced hard, recognising that recession in the US is not imminent, and that the recent period was in fact just a slowdown in growth and an intra-cycle blip. Treasuries also continued to rally as normal correlations broke down for much of the first quarter. The Fed should take the credit for both of these events as Chairman Powell and his committee finally concluded their “pivot” at the recent FOMC meeting, at which members indicated that rates would be on hold for 2019, with just one hike in 2020. The result of this took the 10 year yield down to as low as 2.37% last week, a rally of 87bps since November, or a capital gain of 7.4%. During the latter part of this Treasury rally, some of the data showed signs of bottoming out, both in the US and in China which have been the two main perpetrators of the slowdown. Consequently we are taking stock of the rally in rates, and reviewing where they may go from here. In the last week we have already seen some profit taking on this big move, which to us makes complete sense.

With the Fed Fund range currently 2.25-2.50%, and expectations for US growth and inflation in 2019 both hovering around 2%, the Fed have, understandably, indicated that the next move in rates could potentially move either way and will be data dependent. We therefore feel that the current rate of 10 year Treasuries, which is now at the upper bound of Fed funds (2.50%), and the shorter part of the curve hovering around the mid-point of the Fed Fund range, seems about right and now represents fair value, given the huge change in Fed stance.

Naturally there are still good reasons for holding risk free assets, but for now we think the recent rally is behind us.

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