Key gauge in US bond market casts pall on Treasuries

Borrowing cost that's neutral to growth may be higher, limiting Fed's ability to cut rates

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Just as optimism is growing among investors that a rally in US Treasuries is about to take off, one key indicator in the bond market is flashing a worrying sign for anyone thinking about piling in.

First, the good news. With the midway point of 2024 in sight, Treasuries are on the cusp of erasing their losses for the year as signs finally emerge that inflation and the labour market are both truly cooling. Traders are now betting that may be enough for the US Federal Reserve to start cutting interest rates as soon as September.

But potentially limiting the central bank’s ability to cut and thus setting up a headwind for bonds is the growing view in markets that the economy’s so-called neutral rate – a theoretical level of borrowing costs that neither stimulates nor slows growth – is much higher than Fed policymakers are currently projecting.

“The significance is that when the economy inevitably decelerates, there will be fewer rate cuts and interest rates over the next 10 years or so could be higher than they were over the last 10 years,” said Mr Troy Ludtka, senior US economist at SMBC Nikko Securities America.