Rate Cuts? Not So Fast (Obviously)

Writing about market corrections is hardly exciting. Investors want to know where a market is going and when. The exciting part is when forward steps are being taken, not the times when the market takes a step back.

After almost forty years of making headway towards lower and lower yields, the market has reversed from 2020 to 2023 as yields rose from near zero to something substantial. Ten-year treasury note yields went from .31% March 9, 2020 to 5.02% on October 23, 2023 (yields and prices per Bloomberg). Shorter term yields, like three-month treasury bills, were negative in March 2020, rising to 5.51% last October 6^th.

These were many steps forward in the new trend of higher yields and lower bond prices. But markets do not move in straight lines. A trending market needs to correct, taking a step, or maybe steps, back.

Here is the bad news. Corrections allow the trend to continue. From October 23^rd to December 27^th, the ten-year treasury yield fell from 5.02% to 3.78%. This correction generated a lot of excitement, particularly from those investors who own long term bonds at substantially higher prices purchased when rates were low. Lower yields boosted longer bond prices in the process.

Lower interest rates could signal to the Federal Reserve an all-clear signal on inflation. The idea grew that the next move by the Federal Reserve would be a cut in rates, perhaps several cuts, rather than the constant rate hikes of the past couple of years. Optimism in the bond market was sky high: buy bonds! And as we have discussed on these pages over the past several months, optimism for tax-free bonds and their future performance was at levels seldom seen.

For bullish bond investors, a continuation of the downward trek of recent interest rate moves like 5% to 3.88% was anticipated. Instead, the first few days of April have delivered the opposite. Interest rates on ten-year treasury notes surged and are at their highest in four months, hitting 4.43% on April 3^rd.

A setback for bond bulls? Perhaps. That is the problem with corrections: it is difficult to determine when they are over. So far, this one has taken five months. The 4.40% level is about 50% of the 5.02% to 3.78% move, which may be a key level. The correction may take rates lower from here, below 3.78% and probably take another several months to complete or, if the momentum of this week continues, we may see new highs quickly for ten-year yields instead.

Corrections allow the trend to continue. Whether Punxsutawney Phil sees his shadow or not, spring follows winter, sometimes faster than other times.

The ten-year treasury yield is more of a gauge of optimism anyway. Investors flooding into longer bonds certainly can take yields from 5% to below 4%, but it is not going to have sway over the Federal Reserve rate cuts. Whether the Fed decides to cut rates depends on short term treasury bill yields. With the three-month treasury bill hovering near 5.5% most of last summer, a move down to 5.25% in March and now back to 5.37%, is not going to move the Fed’s needle.

These treasury bill yields are not performing the way bulls need them to behave. A move from 5.5%, to say, 4.5% or something like the move we saw in ten-year treasury yields would be huge…yet it never happened.

In other words, the treasury bill correction has largely been a sideways pause, merely marking time. The earlier excitement of Federal Reserve rate cuts is giving way to the reality that is spelled out in the short term treasury bills: no rate cuts forthcoming.

The Federal Reserve can declare that we will have lower rates for longer and the market might even respond by buying bonds at prices that make lower rates forever the reality. That was 2020 and I called that as the end of the Bond Bull Market and the beginning of the Bond Bear Market. The Federal Reserve does not control interest rates; treasury bill yields control the Federal Reserve.

Recent volatility in interest rates might be responsible for us finding and buying worthwhile bonds. It also might be that other bondholders are giving up and moving on to something else. For us what matters is others selling. The more that they sell, the better our odds of improving your portfolio. That is the game plan; that is The Select Approach^TM.

Austin Independent School District, TX

Unlimited Tax School Building Bonds, Series 2024

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Due 8/1   Dated 4/16/24 Maturity 8/1/49

$692,035,000 Sold

Years   Maturity       Coupon        Yield*

2         2026             5.00%           2.90%

3         2027             5.00%           2.76%

4         2028             5.00%           2.67%

5         2029             5.00%           2.66%

6         2030             5.00%           2.68%

7         2031             5.00%           2.69%

8         2032             5.00%          2.70%

9         2033             5.00%          2.72%

10       2034             5.00%          2.73%

11       2035**          5.00%          2.85%

12       2036**          5.00%          2.93%

13       2037**          5.00%          3.01%

14       2038**          5.00%          3.10%

15       2039**          5.00%          3.16%

16       2040**          5.00%          3.25%

17       2041**          5.00%          3.39%

18       2042**          5.00%          3.46%

19      2043**           4.00%          3.91%

20      2044**           4.00%          4.00%

25      2049**           5.25%          3.85%

25      2049**           5.00%          3.90%

30      2054**           4.25%        4.40%

*Yield to Worst (Call or Maturity) **Callable 8/1/34

Source: Bloomberg

This is an example of a new issue priced the week of 3/25/24

Prices, yields and availability subject to change