Treasury Yields Tick Higher as Traders Prepare to Close Out Wild 2023

On Friday, Treasury yields experienced a modest uptick, positioning themselves to conclude 2023 not far from their starting point. The year proved to be tumultuous, witnessing the 10-year rate reach a 16-year high exceeding 5% before retracing towards the year-end. Investors recalibrated their expectations, anticipating Federal Reserve interest rate cuts in the upcoming year.

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Trading activity on Friday was expected to be subdued, with the industry group Sifma recommending an early closure of U.S. bond markets at 2 p.m. Eastern. The closure would align with the impending New Year's Day holiday, during which financial markets in the U.S. and many parts of the world would remain closed.

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The 2-year Treasury note saw its yield, represented by BX:TMUBMUSD02Y, decline by 2.5 basis points to 4.287%, with yields and debt prices exhibiting an inverse relationship. Meanwhile, the 10-year Treasury note yield, denoted by BX:TMUBMUSD10Y, increased by 4.1 basis points to 3.883%, and the yield on the 30-year Treasury bond, symbolized by BX:TMUBMUSD30Y, rose by 4.8 basis points to 4.037%.

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As of Thursday, the 2-year Treasury yield had decreased by approximately 12 basis points for the year, marking its first annual decline since 2020 according to Dow Jones Market Data. In contrast, the 10-year yield only saw a marginal increase of 2 basis points, and the 30-year yield advanced around 5 basis points, marking its third consecutive annual rise.

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The previous year, 2022, had been notably challenging for bonds, characterized as the worst year on record by certain metrics, as the Federal Reserve aggressively raised rates to combat inflation. In 2023, yields surged once again as the Fed signaled a "higher for longer" rate environment, eventually slowing and pausing rate hikes.

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Despite reaching above 5% in October, the 10-year yield retreated sharply as the Fed not only declared the completion of rate hikes but also hinted at anticipated cuts in the following year. Market participants, however, are pricing in a more assertive series of cuts, expected to commence in the first quarter.

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The decline in yields towards the end of the year played a role in boosting a year-end rally for stocks, as analysts note. The Dow Jones Industrial Average achieved another record close on Thursday, while the S&P 500 lingered just below its record finish from January 3, 2022, with a nearly 25% gain for the year.

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Looking ahead to 2024, the prevailing trajectory for Treasurys appears to be higher with lower yields. However, analysts caution that the decline in yields may not serve as the same catalyst for stock gains in 2024 as it did in 2023. If the 10-year yield continues to drop towards 3.00%, investors may interpret it as an economic warning sign, especially considering the Fed's pivot has already taken place, according to Tom Essaye, founder of Sevens Report Research.