U.S. Bonds Extend Rout Amidst Strong Economic Data and Fed Pushback

The recent surge in strong economic data and pushback from the Federal Reserve has continued to fuel a rout in U.S. bonds. As a result, the benchmark 10-year Treasury yield has risen to 4.163%, marking a significant jump of approximately 30 basis points since the beginning of February. The increase in rates used to finance the economy has contributed to this sharp rise in bond yields, as they tend to move in the opposite direction of prices.

Fed Chairman Jerome Powell has emphasized the importance of caution when considering rate cuts in a recent interview on "60 Minutes." This cautious approach aligns with the Fed's decision to maintain its policy rate at a 22-year high and indicates that a rate cut in March is unlikely.

The effects of this bond market volatility have spilled over into the broader fixed-income market, with the iShares Core U.S. Aggregate Bond ETF experiencing a 0.8% drop on Monday, following a 0.9% slump on Friday. This two-day decline is the ETF's worst performance since October 3, 2023.

It is worth noting that bonds have exhibited high levels of volatility in recent years, which has once again impacted the stock market. The Dow Jones Industrial Average closed 0.7% lower and the S&P 500 index ended down 0.3% on Monday. However, despite these declines, both indexes are still up by 1.8% and 3.6%, respectively, since the beginning of the year.

Market participants are attributing this current state of affairs to a combination of the Fed's cautious stance and robust economic data, which has caused many investors to reconsider their expectations for potential rate cuts this year.

Rate Cuts Still Expected

Despite the volatile conditions in the market, there are still expectations for rate cuts. Robert Pavlik, senior portfolio manager at Dakota Wealth Management, believes that both the recent strong monthly jobs report and positive service-oriented companies data on Monday bode well for investors.

Economic Outlook: Navigating Volatile Markets

The current state of the economy has sparked both optimism and concern among experts. While some view the continued forward momentum as a positive sign, others anticipate a potential rate cut by the Federal Reserve. Analysts predict that gut-wrenching volatility in rates could persist well into 2024.

The ICE BofA Move Index, which serves as a "fear" gauge for bond-market volatility, soared to around 113 on Monday, a significant increase from the previous reading of 106 on Friday. This level of volatility hasn't been seen since the onset of the pandemic in March 2020 and briefly surpassed 200 in March 2023 amidst fears of a banking crisis triggered by Silicon Valley Bank's collapse.

Furthermore, concerns are arising regarding the impact of prolonged higher interest rates on underwater commercial-real estate assets held by banks. The SPDR S&P Regional Banking ETF KRE experienced a 1.7% decline on Monday as a result.

Experts suggest that until the Federal Reserve provides more clarity on the timing of rate cuts, bond volatility will continue to be a key driver of market trends. Abbas at Harris Associates notes that during the period from 2015 to 2021, MOVE index readings ranging from 40 to 80 were more common. Additionally, Michael Miller, president of Wellesley Asset Management, cautions against hoping for a return to historically low interest rates, describing rates around 5% as normal. The Miller Convertible Bond Fund MCIFX, specializing in convertible bonds, has experienced a 1.75% increase year-to-date through Monday.

Interestingly, the sharp increase in yields has led several U.S. bond indexes to shift into negative territory at the start of 2024. Similarly, large bond exchange-traded funds have also experienced negative returns, according to FactSet data.

As we continue to adjust to this new normal, it is crucial for investors to stay informed and navigate these volatile markets with a strategic approach.