U.S. Treasuries achieve the best monthly return in over six months; PCE data will determine the future market direction

The Zhitong Finance APP noted that U.S. Treasury investors are experiencing the largest monthly increase since July of last year, while a series of upcoming economic data will determine whether they can maintain this gain.

This week, the rise in U.S. Treasuries pushed the benchmark 10-year Treasury yield to 4.22% on Friday, the lowest level since December of last year, as a series of weak economic growth indicators rekindled expectations for the Federal Reserve to resume rate cuts after recently pausing interest rate hikes.

Currently, the market's focus is shifting to the January Personal Consumption Expenditures Price Index (PCE) to be released on Friday—expected to show a slowdown in growth—and next week's employment report. As of Thursday's close, the recent decline in yields drove the Bloomberg U.S. Treasury Index up 1.7% in February. This marks the best start for U.S. Treasuries since 2020, with the index rising 2.2% year-to-date.

This reflects the rapid change in the wealth landscape of the world's largest bond market. Just over a week ago, the 10-year yield was above 4.5%, and the market believed this level might attract sellers due to the potential inflationary pressures from the trade war. However, a series of weak secondary economic indicators from the U.S., President Trump's tariff threats, and federal government job cuts have become the main driving factors since then.

Brian Quigley, a senior portfolio manager at Vanguard Group, stated, "The market is indeed forward-looking and is focusing on the ripple effects of government layoffs. If they cut spending, it will reduce funding for other projects, and government contractors may also be negatively impacted."

Investors have exited bearish positions, and activity in the U.S. Treasury options market shows bets that the 10-year yield could fall below 4%. Morgan Stanley strategists indicated that this scenario could occur if investors believe the Federal Reserve will cut rates by another percentage point (about twice the current expectation). This could happen if hiring trends slow down, pushing up the unemployment rate. The first batch of important data for February—including the employment report—will be released next week.

Currently, the Federal Reserve remains on hold due to inflation rates exceeding its long-term target of 2%. However, if it must choose between supporting economic growth and combating inflation, "the Fed will focus on growth," Quigley stated. "Regardless of whether they ease policy in a growth panic, the market will price in more aggressive easing from the Fed."

Citigroup's measure of the deviation of data from economists' expectations reached its most negative level since last September this week George Cartalanbone, Head of Fixed Income at DWS Americas, stated that the company bought when the 10-year U.S. Treasury yield reached 4.8% in January and has now turned neutral on the 10-year U.S. Treasury outlook this week.

As for inflation, the PCE data to be released on Friday is expected to show the core inflation rate, which the Federal Reserve is focused on, slowing for the first time in four months. Janet Rilling, Senior Portfolio Manager at Allspring Global Investments, indicated that inflation concerns may keep the 10-year yield between 4.25% and 4.75%.

"The labor market is basically balanced, but inflation is stubborn," she said. "The inflation issue still requires effort to resolve," adding, "We believe inflation poses risks to the fixed income market. We feel the situation in this regard is still unclear."

The ICE BofA MOVE Index, which measures implied volatility for a basket of fixed income assets, has risen to a six-week high due to changes in Federal Reserve policy expectations. Later on Friday, the bond market may receive support from month-end buying by index funds and other passive investors.

The month-end rebalancing of bond indices (adding securities sold this month and removing those that no longer qualify) is expected to provide above-average support to its duration (a key risk indicator), with adjustments taking effect at 4 PM New York time.

While sellers are prepared for this event, prices could still rise if demand exceeds expectations. The duration is expected to increase by 0.12 years, while the average monthly increase over the past year has been 0.08 years, which is related to the large quarterly auctions of 10-year, 20-year, and 30-year Treasuries in February