(Bloomberg) -- With tension in the Middle East appearing to ease for now, bond managers are turning their gaze back to the U.S. economy, with a particular focus on the risks to the tightest labor market in 50 years.
Traders already predict the Federal Reserve is likely to cut interest rates this year -- even as officials are penciling in steady policy. But the market-implied probability of a 2020 cut has dropped back below 100% on the reduced threat of an imminent escalation of the U.S.-Iran conflict.
With U.S. manufacturing in contraction, any signs that economic weakness is spreading to job creation could bolster the view that the Fed will have to cut rates further after three reductions last year. If it does, Treasuries could build on the 2019 rally that was the best annual performance in eight years.
“There are lots of things out there that have potential to drag on global growth, and if U.S. jobs start to roll over, it’s going to be a very unhappy place,” said James Athey, a portfolio manager at Aberdeen Asset Management in London. “We are bullish Treasuries” and most developed-market sovereign debt, he said.
Athey favors bullish wagers in maturities out to two years in these markets. But he expects 10-year Treasuries to gain as well, with yields likely falling as low as 1% -- from around 1.87% now -- with the Fed cutting several times as it moves into a full easing cycle. Officials have characterized last year’s reductions as merely “insurance” against geopolitical risks.
Swaps traders are pricing in an 80% probability of a Fed rate cut by the end of this year.
Friday’s jobs report is forecast to show employers added 160,000 workers in December. That’d be down from November’s 266,000 pace but still above what’s needed to accommodate population growth. The projected full-year figure would be the slowest gain since 2011.
Even an above-forecast December job figure wouldn’t raise the specter of Fed hikes this year given the signals from officials, said Gene Tannuzzo, deputy global head of fixed income at Columbia Threadneedle Investments. However, it could undermine the case for further cuts, he said.
“If the data makes a-Fed-on-hold scenario seem more likely, then you could see yields rise at the longer end of the curve,” Tannuzzo said.
Long-time bond bull Steven Major, HSBC Holdings Plc’s global head of fixed-income research, reiterated his stance in a note Thursday, telling clients returns would be robust again this year. He expects global growth will persist at levels that keep central-bank policy accommodative for the “long haul.”
The Bloomberg Barclays Global Aggregate Treasuries index returned 5.6% in 2019. The index tracking just U.S. Treasuries earned 6.9%, its best year since 2011.
HSBC’s end-2020 forecasts for key government yields are below current levels. The bank predicts the U.S. 10-year yield will decline to 1.5% by the end of December, and similar-maturity German yields will slide to minus 60 basis points - from minus 18 basis points now.
“Low-for-longer interest rates are a reality, no longer a forecast,” Major wrote in the note.
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