Dovish Fed Keeps Us Bond Rally Bubbling

The Federal Reserve on Wednesday provided the bond bulls with a fresh round of news to keep this year’s fixed-income rally running. As expected, the central bank left interest rates unchanged. As an added bonus for fixed-income markets, the Fed also advised that rate hikes may remain on hold for the rest of the year. And if that wasn’t enough, the bank trimmed its outlook for economic growth in yesterday’s revision of quarterly forecasts and projected that inflation will remain subdued.

Overall, yesterday’s Fed news delivered a perfect storm of bullish news to boost bond prices in every major corner of US fixed-income markets, based on a set of exchange-traded funds. The biggest winner in Wednesday’s trading: Treasuries with maturities ranging from 10 to 20 years via iShares 10-20 Year Treasury Bond (TLH): the ETF jumped 0.9% yesterday.

The latest pop in bond prices (and commensurate fall in bond yields) continued to power the year-to-date rally for all corners of US fixed-income markets. Leading the charge higher so far in 2019: junk bonds. SPDR Bloomberg High Yield Bond (JNK) rallied to a new high yesterday (Mar. 20). Year to date, JNK is up a strong 7.7%, well above the second-strongest performer in the US bond space so far in 2019 via the 5.8% gain for Vanguard Long-Term Corporate Bond (VCLT).

The weakest year-to-date performer is short-term Treasuries. The iShares Short Treasury Bond (SHV) has climbed a modest 0.6% this year through last night’s close.

Yesterday’s Fed news offered several reasons to keep bond bulls optimistic for the near term, starting with the central bank’s signaling that it will remain dovish for the rest of the year. Yesterday’s revised economic forecasts provide support for that guidance. For example, the Fed cut its US growth estimate for 2019 to 2.1% (down from 2.3% in Dec.) and 1.9% for 2020 (down from 2.0% previously).

The Fed’s dovish posture helped squeeze the spread on the widely followed 10-year/2-year Treasury yield spread, which ticked down to 14 basis points on Wednesday — a five-week low, based on daily data via Treasury.gov. The modest spread suggests that the bond market is pricing in expectations of softer economic growth. If and when the spread falls below zero, the slide would be widely interpreted as a forecast that a new US recession is near.

Note, too, that the Fed funds futures market is gradually raising the estimated probability of a cut in interest rates in the months ahead. For the May meeting, the crowd is pricing in a 2.0% probability of a cut, which gradually rises to roughly 47% for the current estimate for next January’s Fed meeting, based on CME data.

Meanwhile, next month’s first-quarter GDP report is on track to post another slowdown in growth. As reported earlier this week, US output is expected to rise at a sluggish 1.4% pace in the first three months of the year, based on the median nowcast via a set of estimates compiled by The Capital Spectator. If correct, economic growth will post a third straight quarter of deceleration after peaking at a 4.2% increase in 2018’s Q2.

It’s “a great time to be patient” with monetary policy, Fed Chairman Jerome Powell advised in yesterday’s press conference. Bond investors have several reasons to read that as an excuse to buy.