March 5, 2020 / 4:10 PM / a month ago

After historic rally, bonds may still have room to run

March 5 (Reuters) - A dramatic U.S. Treasuries rally in the past week that sent yields to historic lows may still have room to run as the spreading coronaviurus leads analysts to downgrade economic growth forecasts, while the Federal Reserve is expected to continue cutting rates.

Yields have tumbled as fears about the virus slammed stocks and led investors to seek out safe haven U.S. Treasuries. Benchmark 10-year yields dropped below 1% for the first time on Monday and on Thursday were 0.93%.

The Federal Reserve on Tuesday cut rates by 50 basis points to a range of 1% to 1.25%. But its first emergency cut since the financial crisis has not yet calmed markets.

“It’s really hard to go 50 basis points before the meeting and then at the meeting do nothing,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets in New York. “For better or worse the Fed might have inadvertently, or purposely, locked themselves into another move in two weeks.”

Two-year Treasury note yields, which are highly sensitive to interest rate moves, have plunged to 0.55%, the lowest since July 2016 when the fed funds rate was in the 0.25% to 0.50% range.

A 25 basis point cut at the Fed’s meeting this month is fully priced in and interest rate futures traders see a 67% chance of a 50 basis point cut, according to the CME Group’s FedWatch Tool.

Further down the line traders see a 31% chance that rates will be 0 to 0.25% by December, the CME data shows.

The spread of the coronavirus has dramatically dented market perceptions of growth, and economic projections are only starting to catch up, said analysts at JPMorgan.

“The next domino to fall is likely growth forecasts,” JPMorgan analysts led by Joshua Younger said in a report on Wednesday.

“To the extent that the tone of macro research remains bullish for Treasuries and points to the risk of further downgrades to global growth expectations, it should serve as yet another headwind against higher yields,” they said.

John Herrmann, a rates strategist at MUFG Securities in New York, sees a deteriorating economic picture with demographic shifts dampening growth, the employment picture worsening and inflation remaining below the Fed’s 2% target.

He expects the Fed to cut rates by an additional 50 basis during the next two meetings, to the 0.50% to 0.75% band, before pausing to the evaluate the impact of the cuts. With growth expected to slow further 2021, however, the Fed is likely to continue rate reductions to zero in an attempt to push back a recession.

“The most logical thing to do is cut to zero before it,” Herrmann said.

That would be revisiting 2008 when the Fed cut rates to the 0 to 0.25% band where they stayed until late 2015.

To benefit from the moves Herrmann recommends that investors hold long positions in short-dated interest rate and fed funds futures contracts. (Editing by Megan Davies and David Gregorio)

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