In the Federal Reserve's interest rate cut transactions at the beginning of this year, the U.S. Treasury market has always been at the forefront of all markets, with bets on the magnitude and timing of the Fed's rate cuts surpassing those of stock and foreign exchange market investors. Consequently, as expectations for a Fed rate cut reignite, the U.S. Treasury market has rebounded accordingly.

Currently, with the September Fed rate cut virtually a foregone conclusion, the U.S. Treasury market is welcoming its fourth consecutive month of gains, setting a record for the longest monthly winning streak in three years. However, some market participants are concerned that the U.S. Treasury market is once again over-betting and over-pricing the prospects of a Fed rate cut, especially with the short-term debt carrying the risk of a subsequent pullback. Furthermore, some analysts believe that even if the Fed is about to enter a rate-cutting cycle, with the economic outlook being uncertain and high inflation expected to persist, the 40% bond portion of the traditional 60/40 stock-bond investment strategy could be partially replaced by commodities.

U.S. Treasuries have recorded four consecutive months of increases. According to the Bloomberg U.S. Treasury Total Return Index, as of August 28, the overall return rate for U.S. Treasuries this month was 1.7%, on track to achieve a rise for the fourth consecutive month, with a cumulative increase of 3% for the year.

Among them, short-term U.S. Treasuries, which are the most sensitive to interest rates, have seen the most significant gains. According to data compiled by the media, in August, money market funds invested in short-term U.S. Treasuries recorded an inflow of $106 billion, bringing the total asset size of these funds to a historical high of $6.24 trillion.

Advertisement

Driven by this, the yield on two-year U.S. Treasuries fell to about 3.9% this afternoon, less than 2 basis points higher than the yield on ten-year U.S. Treasuries. In contrast, in March 2023, the spread between the two exceeded 100 basis points, recording the most severe yield curve inversion since 1981. Bond traders are currently betting that the Fed will cut rates by about 100 basis points within the year, which means that rate cuts could be announced at each of the Fed's policy meetings from September to December, with one of them potentially being a 50 basis point cut.

The U.S. Treasury market may be overpricing the Fed's rate cut. Since U.S. Treasury investors are currently making bets that are as aggressive as they were at the beginning of the year, many market participants worry that this rebound in U.S. Treasuries may have overpriced the prospects of a rate cut. The future risk lies in the possibility that if the U.S. labor market remains stable afterward, the pace of Fed rate cuts may be slower than widely expected in the bond market. For instance, on Thursday (August 29) Eastern Time, the U.S. second-quarter Gross Domestic Product (GDP) and weekly initial jobless claims indicated a strong economy, causing U.S. Treasury prices to fall and yields to rise. On Friday (September 6), the U.S. will release the August non-farm employment data. Meghan Swiber, a rate strategist at Bank of America, said: "I am surprised by the rapid and intense shift in sentiment in the U.S. Treasury market, but the current data does not fully justify the Fed cutting rates quickly and aggressively this year."

In particular, many analysts believe that short-term U.S. Treasuries may soon give back recent gains. Michael Brown, a senior research strategist at Australia's Pepperstone, a financial group, wrote in a research report that the recent flattening of the U.S. Treasury yield curve is a notable feature, with the spread between two-year and ten-year U.S. Treasuries approaching a return to positive territory by the end of last week. However, given that the market's recent bets on Fed rate cuts seem a bit excessive, short-term U.S. Treasuries should soon give back recent gains, leading to an increase in short-term bond yields. His base expectation remains that the Fed will cut rates by 25 basis points in September.

JPMorgan also believes that investors should reposition their bond investment strategies, selling short-term debt and shifting to long-term debt. The JPMorgan analyst team stated that during the previous era of Fed policy tightening, high yields had spread across all maturities (U.S. Treasury bills maturing in a few weeks to a year). Since Treasury bills are very sensitive to tight monetary policy, U.S. Treasury bill yields have risen above 5% since 2022. However, as the September rate cut approaches, investors can no longer rely long-term on short-term Treasury bills. The bank expects that over the next 18 months, the three-month bill rate will drop from 5.4% to 3.5%. If the U.S. economy slows down more than expected, the decline could be even more significant. Moreover, during the rate-cutting cycle, short-term Treasury bills have consistently underperformed long-term U.S. Treasuries, and traders may miss out on other bond investment opportunities by continuing to hold short-term U.S. Treasuries and other cash equivalents.In addition to reshuffling long-term and short-term U.S. Treasuries, JPMorgan's advice on the overall rebalancing of fixed-income asset investments is also based on the reason for the Federal Reserve's interest rate cuts. The bank stated that when the Fed lowers interest rates due to an economic recession, long-term U.S. Treasuries usually perform well in fixed-income investments, and investment-grade bonds should also be the main investment category, while high-yield bonds will record negative returns. However, if the Fed's interest rate cuts are accompanied by a soft landing (the economy does not enter a recession and inflation falls back to the target level), high-yield bonds can bring positive returns, and the returns are higher than those of U.S. Treasuries.

Replace U.S. Treasuries with commodities?

Furthermore, Michael Hartnett, the Chief Investment Strategist at Bank of America, recently suggested in a research report that investors adjust the traditional 60/40 portfolio strategy, replacing the 40% bond portion with commodities. According to media data, the combined return rate of global stocks and bonds in 2024 is close to 16%, expected to achieve growth for the second consecutive year. However, Hartnett said, "Considering the current global economic situation, commodities may perform better in the future economic cycle, even surpassing the performance of traditional bonds."

Specifically, Bank of America believes that multiple factors will continue to drive up commodity prices, including the rise in global debt, the expansion of fiscal deficits, changes in population structure, the trend of deglobalization, the promotion of artificial intelligence, and the implementation of net-zero carbon emission policies by governments. Over the next decade, these factors, when combined, will continue to create inflationary pressures, thereby supporting a long-term bull market for commodities. Therefore, the bull market for commodities in the 2020s has just begun, and this asset class has maintained an annualized return rate of 10% to 14% since the early 20th century. In contrast, the investment return of 30-year U.S. Treasuries over the past four years is -40%. "Therefore, although bonds are still an effective investment category for hedging stock risks in the context of an economic hard landing, commodities have more advantages in a high inflation environment, and it is expected that the overall returns of commodities in the 2020s will be 40% higher than U.S. Treasuries."