Treasuries Have a Hard Act to Follow in 2020 as Optimism Rises

(Bloomberg) -- It’s difficult to imagine how Treasuries can top their performance from 2019 in the coming 12 months.

The world’s largest bond market is on track for its strongest year since 2011, with a total return close to 7%, based on Bloomberg Barclays index data. But with 10-year rates now down at around 1.88%, the scope for additional capital gains is more limited. Moreover, the market is entering 2020 in reverse gear. A sell-off in the last quarter trimmed its gains, driving the benchmark up almost a half percentage point from its multi-year low of 1.43% in September.

The key to a market rebound in the new year will be the health of the U.S. consumer, according to TD Securities’ Priya Misra. The rates strategist expects renewed rallies in Treasuries as the slump in U.S. manufacturing spills over into weaker consumption, which has been the engine of this record economic expansion. In her view, that will motivate traders to reinstate bets on further easing from the Federal Reserve, and bring an interest-rate cut in the first quarter.

“I think we seem to be at this inflection point where a lot hinges on the U.S. consumer,” she said. “We’re pricing a little less than one cut in 2020, which tells me that a real slowdown in consumption isn’t priced in, and it could turn on a dime.”

Positioning for another Fed rate cut has all but disappeared in the last couple of months, as investors have gained confidence in the growth outlook. Progress on a U.S.-China trade deal helped, as did a modest recovery in manufacturing data in Europe and China. U.S. factories are still struggling, however, with the last crop of reports showing the sector still in contraction. The latest readings on these are due next week, and economists anticipate continued weakness.

That’s somewhat out of step with the Fed’s latest pronouncements, as Chairman Jerome Powell this month told reporters the economy is “in a good place.” Investors on Friday will be parsing the minutes of the central bank’s December deliberations for more color on the thinking behind the unanimous decision to keep rates on hold, and policy makers’ apparent preference to keep them that way for the coming year.

But even before traders can turn their attention to the year ahead, those focused on the short end of the market must get through the next few days. The final stretch of 2019 presents the biggest risk of renewed upheaval in funding markets, and all eyes are on the possibility of a repeat of the spikes in overnight rates seen back in September. The Fed’s actions since then appear to have helped tide the financial system over a potentially volatile period, but if not, it could be a rocky start to the new decade.

What to Watch

• The U.S. economic data calendar is pretty sparse over the turn of the year, but Fed speakers and the release of minutes from December’s Federal Open Market Committee meeting might get attention on Friday
• The Treasury market will be closed at 2 p.m. New York time on Tuesday, ahead of the New Year public holiday, and will be shut globally on Jan. 1
• Manufacturing reports dominate the week’s economic indicators:
  • Dec. 30: Trade balance; Wholesale and retail inventories; MNI Chicago PMI; pending home sales; Dallas Fed manufacturing activity
  • Dec. 31: FHFA house price index; S&P CoreLogic home prices; Conference Board consumer confidence
  • Jan. 2: Jobless claims; Bloomberg consumer comfort; Markit manufacturing PMI; ISM manufacturing gauge; construction spending
  • Jan. 3: Total vehicle sales
• Fed speakers pop up on Friday:
  • Jan. 3: Richmond Fed’s Thomas Barkin speaks in Baltimore; Governor Lael Brainard, San Francisco’s Mary Daly and Chicago’s Charles Evans join a panel at the annual American Economic Association meeting in San Diego, followed by Dallas Fed’s Robert Kaplan; Minutes of the Dec. 11 FOMC meeting are also scheduled for release
• Treasury bills are the focus for the auction calendar:
  • Dec. 30: $42 billion of 13-week bills; $36 billion of 26-week bills; $26 billion of 52-week bills
  • Jan. 2: 4-week and 8-week bills

To contact the reporter on this story: Emily Barrett in New York at ebarrett25@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Debarati Roy

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