Super-sized Fed rate cut “good” for US Treasury yield spreads – BofA

Investing.com — The Federal Reserve’s decision to aggressively slash interest rates will likely be “good” for spreads between US Treasury yields, according to analysts at Bank of America.

The spread between the rate-sensitive 2-year and benchmark 10-year US Treasury yield, an indicator of future growth projections, steepened to its highest level since 2022, as investors reacted to the Fed’s announcement that it had slashed rates by 50 basis points rather than a more traditional quarter-point reduction.

“A 50-[basis point] cut is good for spreads. The bigger cut is good for both [investment grade] technicals and fundamentals,” the BofA analysts said in a note to clients following the announcement.

They added that the updated “dot plot” of officials’ forecasts signalled that policymakers may be gearing up to unveil a “relatively rapid” easing cycle as the central bank attempts to stem any potential weakening in the economy after a period of elevated rates.

However, they flagged comments from Fed Chair Jerome Powell suggesting that the deeper rate cut size was a “recalibration” of monetary policy and not “the new pace” of drawdowns. They noted that Powell also said that the rate-setting Federal Open Market Committee was not in a “rush” to slash borrowing costs.

Taking the Fed’s projections and Powell’s comments into account, the BofA analysts said that officials are eyeing 100 basis points in cuts by the end of 2024, or “25[-basis point] cuts each [at the Fed’s next gatherings in] November and December.”

“That’s hawkish relative to [the roughly] 120 [basis points] of 2024 cuts currently priced by the market,” they said.

They added that US yield curve has subsequently seen a “bear steepening,” in which the long-term yield rises faster than the short-term yield. Prices and yields tend to move inversely.

This trend, they said, “supports demand due to higher yields and lower [foreign exchange] hedging costs” for overseas investors.