Is the U.S. Bond Bull Market Over?

At the beginning of the month, consecutive weak manufacturing PMI and non-farm payroll data sparked market concerns about a recession, leading to heightened expectations of interest rate cuts. Consequently, the U.S. Treasury yield curve shifted downward, with the 10-year yield briefly dropping below the psychological threshold of 3.8%. As global stock markets rebounded, U.S. Treasury yields also saw a slight recovery, with the current 10-year yield fluctuating between 3.8% and 3.9%.

Currently, market concerns about a further rise in U.S. Treasury yields stem primarily from the belief that a recession cannot be confirmed in the short term and that economic data may rebound once disruptions subside. It is widely believed that the unexpectedly low non-farm payroll figures in July were significantly influenced by hurricane conditions. The sustained high levels of the services PMI and the better-than-expected decline in weekly jobless claims also indirectly suggest that the short-term recession risk may not be as high as the market anticipated, indicating a potential for rate cut expectations and U.S. Treasury yields to adjust downward.

I believe that the bull market journey for U.S. Treasuries is not yet over, and the overall risk of a pullback is limited, especially for short-term 2-year Treasuries. Conversely, 10-year or longer-term Treasuries might be somewhat undervalued, with the bottom for the 10-year yield potentially adjusting down to 3.5%. Amid fluctuating short-term rate cut expectations, investors could adopt a "short 2-year, long 10-year" strategy to hedge some of the risks.

1. Inflation Target and Rate Cut Space: Even without considering recession risks, in a soft landing scenario, hitting the inflation target would still provide room for a 200 basis point rate cut over the next 1-2 years. Although the rate cut expectations priced in by the futures market seem somewhat aggressive, they are not overly so.

2. Model Estimates and Historical Comparisons: Under a soft landing rate cut path, model estimates suggest that the 10-year U.S. Treasury yield could center around 3.6%. During the Silicon Valley Bank crisis last year, the 10-year yield dropped to around 3.3% amid similar rate cut expectations.

3. Yield Curve Cost-Effectiveness Analysis: The downward deviation in the 2-year U.S. Treasury yield has become quite significant. Even considering some pro-cyclicality, the short-term cost-effectiveness is lower compared to 10-year and longer-term Treasuries. Over the past month, strategies focusing on steepening the yield curve have yielded substantial returns, but they may not retain this advantage in the short term.

4. Economic Data Rebound and Fed Stance: In the short term, economic data might rebound after disruptions, and the Federal Reserve's stance could remain neutral, leaving room for a cooling of rate cut expectations. If concerned about potential upward adjustments in U.S. Treasury yields, investors could hedge some risks by shorting 2-year Treasuries while holding 10-year Treasuries.

In this grand financial market feast, investors need to act like astute masters, discerning every subtle change in economic data, and seizing every fluctuation in interest rate trends to achieve steady asset growth.