Global bonds slump as traders reconsider Fed rate cut path

(Bloomberg) — Bonds extended Monday's sharp losses as investors mulled the prospect of a gradual U.S. interest rate cut, a trend that risks increasing debt positions everywhere.

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The 10-year yield rose as much as two basis points, above 4.20% for the first time since July. Rates on equivalent German securities rose four basis points, touching the highest level since early September. The path also spread to Asia, where Australian benchmark debt yields rose as much as 16 basis points.

At the heart of the sell-off is a reassessment of the US monetary policy outlook. Traders are backing off bets on aggressive easing as the U.S. economy remains firm and Fed officials this week struck a cautious tone on the pace of future rate cuts. Rising oil prices and the prospect of a large fiscal deficit after the upcoming US presidential election are fueling market anxiety.

“With the US election less than two weeks away, concerns about the financial outlook and its potential upward pressure on inflation have intensified,” said Robert Dishner, senior portfolio manager at Neuberger Berman in London.

US 10-year yields jumped 10 basis points on Monday. The move further widened a key part of the U.S. yield curve that has inverted since late 2022, with the gap between the three-month and 10-year yields narrowing to the narrowest level in nearly two years.

“We'll probably see 4.5% early next year,” said Ed Yardeni, founder of Yardeni Research, in an interview on Bloomberg Television.

Traders priced the Fed's interest rate cuts to September 2025 by more than 10 basis points since late last week, according to swaps, implying a Fed target rate of between 3.50%-3.75%.

Apollo Management is among those who believe the central bank is likely to keep rates unchanged at its next meeting, where T. Rowe Price sees US 10-year yields at 5% next year due to the risk of a shallow rate cut and improving growth.

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The outlook is being repcied across other markets. Swaps are signaling that the Reserve Bank of Australia will cut its benchmark rate by around 50 basis points by the end of August next year, half the price set after the September policy meeting. Similarly, traders raised their forecasts for the next Bank of Japan rate hike, compared to the end of July seen last month.

Demand for long-term holdings of Japanese 10-year bonds, “which carry relatively high interest rate risk, may be limited in this environment,” said Keisuke Tsuruta, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo, wrote in a research note.

Emerging-market bonds also fell, with Indonesia's five-year yield rising seven basis points.

Not everyone expects to gain sales momentum. The Fed and Reserve Bank of New Zealand, among others, are in a rate-cutting cycle, which should create an underlying bid for bonds.

“We probably see a slight correction from here,” said Lucinda Haremza, vice president of fixed-income sales at Mizuho Securities in Singapore. “There is a risk of escalation in Middle East tensions or a strong rally for Harris to win the election,” he said.

For now, though, Treasuries may see larger-than-usual fluctuations in U.S. debt supply, election hedging and countering the risk of a Republican “red sweep” in markets. Treasury volatility reached its highest level this year based on the ICE Bofa Move Index, which tracks expected swings in U.S. yields based on options.

BlackRock Investment Institute is one of those underweight small-maturity treasuries.

“We don't think the Fed will cut rates as quickly as the market expects,” strategists at the firm, including Wei Li, wrote in a note. The effects of structural changes such as an aging workforce, persistent budget deficits and geopolitical fragmentation “should keep inflation and policy rates high over the medium term,” they wrote.

— With assistance from Haslinda Amin, Anchali Orachate and Alice Gledhill.

(Update price.)

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