Will US Treasuries Strengthen by Year-End? Analysis: Unrelated to Rate Cuts, but a "Return of Risk Aversion"

At the end of the year, the U.S. Treasury market may show a positive trend, which is not closely related to expectations of Federal Reserve policy, but rather stems from historical data indicating seasonal patterns—investor risk appetite declines in the autumn, driving up demand for safe-haven assets.

Last week, Federal Reserve Chairman Powell stated that a rate cut in December is "not a done deal," leading to a significant cooling of market expectations for a rate cut. According to the CME FedWatch tool, the probability of a rate cut in December has dropped from about 90% before Powell's press conference to 72% now.

However, a major advantage for bond investors at present is that the U.S. Treasury market exhibits a fairly stable seasonal pattern, with prices peaking in late autumn and bottoming out in spring. This pattern may offset investors' disappointment regarding the Federal Reserve's policy stance.

Seasonal Patterns Trace Back to the 1970s

The seasonal characteristics of the U.S. Treasury market have not always existed; they originated in the early 1970s when the U.S. Treasury began selling bonds through public market auctions.

A study published in the Critical Finance Review in 2015 indicated that before the establishment of a market-based pricing mechanism, U.S. Treasury yields showed almost no seasonal variation. However, after the introduction of the auction mechanism and the issuance of Treasury bonds began to follow a regularly predictable schedule, seasonal variations became a stable feature of Treasury bonds.

Data shows that the average return on U.S. Treasuries in December is mediocre, but when combined with November, its return is higher than that of any other two-month combination throughout the year. This seasonal pattern has remained relatively stable over the past half-century.

Safe-Haven Sentiment Driving Mechanism

Researchers initially analyzed various hypotheses to explain the causes of the seasonal pattern in Treasury bonds, including macroeconomic seasonality, seasonal changes in risk, weather factors, cross-hedging between stock and bond markets, traditional measures of investor sentiment, the seasonal schedule of Treasury auctions, seasonal supply of Treasury bonds, and the seasonality of the Federal Open Market Committee cycle, but all were ruled out one by one.

Ultimately, researchers found a reasonable explanation: the seasonal variation in investor risk aversion. Specifically, in autumn, investors begin to be affected by seasonal mood disorders, which in turn affects their willingness to take on risk.

Researchers wrote:

“If investors feel down in the autumn, leading to increased risk aversion, then Treasury bond prices should rise, resulting in actual yields on Treasury bonds in autumn being higher than average. Then, when investor sentiment rebounds in spring and risk aversion decreases, Treasury bond prices will fall, leading to actual yields being lower than average.”