A Rate Cut In March Could Be Possible, As Waller's Latest Dovish Speech Brings Market Another Hope

The US. Treasury yields continued to decline on Thursday, with the entire yield curve now erasing the gains seen after last Friday's nonfarm payrolls data, particularly in the long end where the drop was more pronounced.

The most notable event on Thursday was the speech by Federal Reserve's Christopher Waller, a former prominent hawk within the Fed who now appears to have fully turned dove: he not only believes that the Fed still hopes to cut rates three to four times this year, but also does not rule out a rate cut as early as March...

Market data showed that following Waller's speech, U.S. Treasury yields across all maturities fell overnight. The 2-year Treasury yield fell 3.4 basis points to 4.238%, the 5-year yield fell 4.8 basis points to 4.404%, the 10-year yield fell 3.9 basis points to 4.618%, and the 30-year yield fell 2.3 basis points to 4.859%.

According to LSEG data, after Waller's remarks, the market's expectation for the Fed's rate cut in 2025 increased from about 37 basis points late on Wednesday to about 44 basis points. The market also believes that there is a 69% probability of the next rate cut occurring at the Fed's June meeting.

Before Waller's speech, traders had expected the next rate cut to come sometime after the first half of the year.

Waller's latest comments on Thursday have certainly overturned many people's previous impression of him as a hawk. Waller said on Thursday, "The inflation data we got yesterday was very good."He noted that if such data continues, there is reason to believe that rate cuts could come in the first half of the year. Waller also said that he does not completely rule out a rate cut in March.

Waller further stated that officials' median estimate of the neutral rate implies that there could be three to four rate cuts this year, depending on the economic data released.

After Waller's comments, the 2-year U.S. Treasury yield, which is sensitive to monetary policy, fell to an intraday low of 4.25%. The market also further believed in the Fed's December dot plot prediction of two rate cuts this year. Of course, although Waller said he does not rule out a rate cut in March, the rate futures currently only price in a 33% probability for a rate cut in that month. To achieve this, more data and official statements may be needed...

On the economic data front, the U.S. December retail sales data released on Thursday was below expectations, and the number of initial jobless claims last week was also higher than expected, which to some extent continued to drag down U.S. Treasury yields.

The data showed that U.S. retail sales grew by 0.4% in December, below the expected 0.6% growth, although the gains in the previous two months were revised upwards. At the same time, the number of initial jobless claims rose to 217,000 last week, after a decline in the previous week. Meanwhile, U.S. import prices only rose slightly in December, marking the third consecutive month of increase, suggesting a mild inflation outlook.

John Luke Tyner, head of fixed income at Aptus Capital Advisors and portfolio manager thinks the U.S. economic data is still soft, which should help the year-over-year data move in the right direction. If a few more data like CPI pop up in the next few months, two rate cuts will likely happen this year.

Regarding the current situation of the U.S. Treasury market, Bank of America interest rate strategists said that the 10-year U.S. Treasury yield still faces upward pressure from economic and inflation expectations, but it is likely to stop at a maximum of 5.25%.

BofA interest rate strategists Ralph Axel, Bruno Braizinha, and Mark Cabana said in a report that 5.25% is possible, but it is a relatively high level. We tend to believe that yields will maintain the recent upward trend, especially approaching the 5% mark. The bank's year-end forecast for the 10-year Treasury yield is 4.75%.

The bank said that since mid-September, the drivers of the rise in U.S. Treasury yields have included the improvement of the U.S. economic fundamentals and concerns about the oversupply of Treasury bonds. Assuming that inflation remains stubborn or only falls slightly, as long as the market continues to digest remaining rate cuts or believes that the Fed will hold steady, the expected rate may remain below 4.83%. If the 10-year Treasury yield reaches 5%, it will be an attractive buying opportunity.