After the major shift by the Federal Reserve, increasing holdings of short-term US bonds has become the new consensus on Wall Street.

Zhitong App has learned that with market expectations of the Federal Reserve's shift towards monetary easing, investors generally believe that bonds with shorter holding periods and yields above 4% are currently the best investment option.

US bond investors believe this is because as inflation rates decline, the Federal Reserve is preparing to lower interest rates to support a soft landing. At the same time, due to investor concerns that investment rates for cash assets may soon decline significantly, a large portion of the nearly $6 trillion in money market mutual funds has a new reason to turn to US Treasury bonds.

In addition, the market firmly believes that the economy may avoid what was once seen as an almost inevitable recession. Furthermore, investors lack interest in long-term securities as they expect the yield curve to steepen and return to a more typical upward trend. The consensus on Wall Street is now very clear: two-year US Treasury bonds are the best investment on the yield curve, with a yield of around 4.4%, which is more attractive than any other maturity of government bonds.

Lindsay Rosner, portfolio manager at Goldman Sachs Asset Management, said, "The Fed has given us expectations for the interest rate path in 2024 and 2025, and the result is lower interest rates." She suggests that investors should focus on a mix of two-year and five-year US bonds because "we don't see much investment value outside the yield curve."

As traders hope to be compensated for the additional risks associated with long-term US bonds, they expect these long-term securities to underperform. Concerns include continued heavy issuance of debt to finance the ongoing high US government deficit and the tail risk of inflation reigniting next year.

In fact, the attractiveness of two-year US bonds can be easily seen from the yield curve. One and a half years ago, the yield curve first inverted, causing long-term rates to fall below those of shorter-term bonds. Now, a large number of investors are betting that at some point next year, the yield curve will return to a more common pattern. Currently, the yield on 10-year US bonds is still about 50 basis points lower than that of two-year bonds. Just in July, this spread was over 100 basis points.

After the Federal Reserve meeting last week, in a survey conducted by MLIV Pulse, 68% of respondents predicted that the yield curve would turn positive in the second half of 2024 or later. Meanwhile, 8% believed it would happen in the first quarter, and 24% said it would happen in the second quarter.

Prominent investors, including DoubleLine Capital founder and "New Bond King" Gundlach, Pacific Investment Management's "Bond King" Gross, and billionaire investor Ackman, all predict that the yield curve will return to normal. Gundlach said that the yield on 10-year US bonds will drop to a low of 3% next year, while Gross and Ackman believe that by the end of 2024, the yield may exhibit a positive slope. Last Wednesday, Federal Reserve policymakers indicated that there would be no further interest rate hikes and that the target range would be maintained between 5.25% and 5.5%. The officials' quarterly projections also showed a 75 basis point rate cut next year, with the federal funds rate expected to drop to 3.6% by the end of 2025 and to 2.9% by the end of 2025.

Although New York Fed President Williams later stated that it was "too early" to talk about a rate cut before March, market expectations for a rate cut remained largely unchanged. The futures market indicates an 80% probability of a rate cut by the Fed as early as March next year. Overall, the market expects a total rate cut of 164 basis points by the end of 2024.

In Europe, despite central banks lowering market expectations, investors are also trying to figure out how to trade on this basis point. For the European Central Bank, traders expect the bank to cut rates by 25 basis points six times by 2024, while in the UK, the market is betting on a 115 basis point rate cut next year, which means at least four 25 basis point cuts, an increase of 40 basis points from a week ago.

Nevertheless, Michael de Pass, Global Head of Interest Rate Trading at Citadel Securities LLC, still warns that there are potential pitfalls in this process. "Of course, at this stage, it seems that all markets are pricing in a perfect soft landing, but any deviation from this narrative carries the risk of repricing."