In a significant shift for the financial markets, short-term Treasuries experienced a rise as traders adjusted their forecasts for Federal Reserve interest-rate cuts following a notable contraction in the U.S. economy. This contraction marks the first such decline since 2022, prompting a reduction in yields on two-year notes by approximately four basis points. This movement comes in light of recent data indicating a dip in gross domestic product (GDP), tempered consumer spending, and a stable inflation measure favored by the Federal Reserve.

Market Reaction to Economic Data

The swaps market responded dynamically, with traders increasing their bets on four potential quarter-point rate cuts by the end of the year, the first of which is fully anticipated for July. Zachary Griffiths, who leads U.S. investment grade and macro strategy at CreditSights, commented, “This reinforces existing concerns about stagflation, especially before many tariffs take effect. The market’s reaction reflects this sentiment.”

• Key Developments:
  • GDP decreased by an annualized 0.3% in the first quarter.
  • Inflation-adjusted figures indicated a slowdown compared to an average growth of 3% over the previous two years.

Treasury Auction Guidance and Market Expectations

In contrast to the positive movement in short-term securities, thirty-year yields saw a rise due to investor disappointment over the Treasury’s decision to keep auction sizes steady for the upcoming quarters. The Treasury plans to auction $125 billion worth of securities during the next quarterly refunding, covering 3-, 10-, and 30-year maturities.

Market analysts had hoped for a more aggressive approach from Treasury officials to alleviate supply concerns. Citigroup’s strategists recently suggested that the yield curve might steepen if buybacks are not increased. According to Wells Fargo strategists Angelo Manolatos and William Gibbons, “While the guidance remained unchanged, the reaction in longer-dated bonds suggests that the market expected more from the Treasury regarding liquidity support.”

Yield Curve Dynamics

The underperformance of longer-dated bonds has widened the yield gap between five- and thirty-year yields to 92 basis points, with the curve steepening about 30 basis points in April. This trend indicates that investors anticipate a slowing economy will eventually prompt the Fed to lower borrowing costs, despite inflation and bond supply pressures keeping long-term yields elevated.

Economic Insights and Future Outlook

Recent data underscored that inflation-adjusted GDP fell by 0.3%, contrasting sharply with previous years’ performance. Furthermore, a closely monitored measure of underlying inflation surged to a 3.5% rate in the first quarter, the highest in a year. Jordan Rochester, head of macro strategy for EMEA at Mizuho International Plc, noted, “The main market driver is the upside in consumption, followed by a robust price index. Current GDP figures indicate that the primary concern is not sluggish growth, but rising prices and significant import accumulation.”

As the week progresses, attention will turn to the upcoming U.S. jobs report, which is anticipated to reveal the creation of 135,000 new jobs in April, a decline from 228,000 in March. The evolving economic landscape continues to keep investors on their toes as they navigate these changes.