The bond market in 2024 continues to exhibit topsy-turvy dynamics, with yields on short-term bonds exceeding those of longer-term bonds. For example, as of the end of February 2024, 3-month Treasury bills yielded 5.45% and 2-year Treasury yields were 4.64%, while the yield on 10-year Treasury notes was even lower, at 4.25%.1 However, investors are anticipating a change in the interest rate environment in 2024.
The current rate structure emerged after the Federal Reserve (Fed) began raising the short-term interest rate it controls – the federal funds rate – in early 2022. Between March 2022 and July 2023, the Fed raised rates eleven times, from near 0% to an upper range of 5.50%. Since then, the Fed has held the line on further rate hikes and made clear that it will begin cutting rates in 2024, reversing its previous policy.
The Fed's intended policy change is likely to reverberate across the broader bond market. “If the Fed cuts short-term interest rates, yields on shorter-term debt issues are likely to decline,” says Haworth.
The major question for the market is the Fed’s interest rate-lowering timeline. “Markets got well ahead of expectations for 2024 rate cuts,” says Haworth. At the December meeting of the policy-making Federal Open Market Committee (FOMC), the indication was that three cuts would occur in 2024. “The markets, however, appeared to anticipate many more 2024 rate cuts, and long-term bond yields began to drop as a result.” says Haworth. “By early 2024, the reality set in that for now, the Fed is maintaining higher rates for longer than the markets initially anticipated.” As a result, bond markets backtracked, and rates trended higher in recent months.
How might the bond market perform this year and what does that say about how to incorporate or adjust strategies for fixed-income investors?
Changing bond market
Despite the recent decline in bond yields, they remain significantly higher than was the case at the start of 2022. “Three key factors drove the jump in bond yields,” says Bill Merz, head of capital markets research at U.S. Bank Wealth Management. “First is the Fed’s policy response to inflation. Second is the strength of the U.S. economy. Finally, there is an increasing supply of U.S. Treasury securities coming to the market.”