U.S. Treasuries have been on a roller coaster ride this year. Yields kept climbing until May, as rate cut expectations were repeatedly thwarted. Since then, with the gradual recovery of these expectations and the impact of geopolitical risks, the trend has reversed. The 10-year note yield has dropped 37 basis points to 4.26%, and the 2-year yield has fallen below the 4.8% mark. The Bloomberg Treasury Index is now almost back to where it started the year, with just a 0.1% dip. As yields peak and retreat, they're inching closer to their year-ago levels, signaling a recovery for U.S. Treasuries.

Sluggish Macro Data Bolsters Rate Cut Expectations, Fueling Optimism in the Bond Market

Retail sales in the U.S. edged up by a modest 0.1% in May, according to data released on Tuesday, falling short of the anticipated 0.3% increase. Last week's inflation figures indicated a larger-than-expected decline, with the core CPI dropping to a three-year low and the May PPI falling 0.2% month-over-month, contrary to expectations of a 0.1% rise. More disappointing data followed on Thursday: initial jobless claims for the week totaled 238,000, exceeding the expected 235,000, while new housing starts in May plummeted by 5.5%, marking the lowest level in four years.

Despite Fed Chair Powell's hawkish stance on rate cuts following the FOMC meeting, the market remains focused on weak economic data. According to CME FedWatch, expectations for a rate cut in September have risen to 64.1%, with two 25 basis point cuts anticipated by 2024.

According to Bloomberg, the past week has seen a significant surge in demand for futures contracts in the bond market; the momentum in the spot market is also gaining strength, with a JPMorgan survey indicating the largest net long position in the spot market in about a month. Meanwhile, the auction of $13 billion in 20-year U.S. Treasury bonds yielded significantly lower rates than pre-auction yields, signaling stronger-than-expected demand.

Why the Bond Market Is Poised for a Bull Run Amid Rate Cut Expectations

As the prospect of an interest rate cut looms, U.S. Treasury yields are poised to continue their descent, presenting opportunities for bond allocation.

1. Market expectations of a rate cut are driving the downward movement of risk-free rates, providing solid support for bond prices. Bart Melek, Head of Commodity Strategy at TD Securities, said, "The market is increasingly convinced that the Federal Reserve will initiate an easing cycle. I believe we may start to establish some long positions in the market."

2. With the soaring stock prices of major tech companies like Nvidia and Apple, investors are concerned about the sustainability of the stock market's rally and are looking to diversify into lower-risk assets such as bonds.

What Type of Bonds to Choose for the Upcoming Rate Cut?

Some analysts are optimistic about investment opportunities in long-term bonds.

Rachana Mehta, Regional Co-Head of Fixed Income at Malayan Banking Asset Management, believes that the yield on the 10-year U.S. Treasury note is roughly between 4.2% and 4.5%. She thinks it's a good buying opportunity when the yield approaches the top of this range. Mehta said, "Given the recent U.S. data, we hope the volatility we've seen is behind us." "You can continue to hold the 10-year U.S. Treasury note with yields of 4.4% to 4.5%."

Padhraic Garvey, Global Head of Debt and Interest Rate Strategy for Financial Markets at ING Group, said, "We continue to see 4% as a viable target for the yield on the 10-year U.S. Treasury note.

Opinions are divided, with some analysts bullish on short-term Treasury bonds due to their heightened sensitivity to monetary policy. Since the start of the year, the yield curve inversion between the 2-year and 10-year U.S. Treasuries has significantly tightened, with the spread narrowing by 51 basis points to 48 basis points.

It's important to note that not everyone is bullish on U.S. Treasuries. Earlier this month, analysts Anshul Pradhan and Amrut Nashikkar at Barclays wrote in a report that the market may be overinterpreting the weakness in recent data such as CPI. 'We believe that a rebound in economic activity could surprise the market and lead to higher interest rates,' they wrote.

Beyond U.S. Treasuries, there are other bonds with investment opportunities. David Kelly and his team at JP Morgan Asset Management believe that 'as the Fed eventually begins reducing rates, core high-quality intermediate bonds should prove to be an equity diversifier and ballast in client portfolios once again.'

Michel Vernier, Head of Fixed Income Strategy at Barclays, mentions 'A mix of medium-term investment grade credit in combination with other segments, like high yield (BB-rated), emerging markets, and some inflation-linked debt, seems to be a reasonable approach to meet uncertainty over the upcoming path while delivering likely higher returns than cash over the long term.'"