Jerome Powell has the bond market exactly where he wants it: lacking conviction as to the Federal Reserve’s next steps.
It’s a scenario — evident in part through split futures positioning — that gives the Fed chair and his colleagues leeway to quickly adjust policy in the coming months as economic data unfolds, without having to fret about potentially roiling the world’s biggest fixed-income market.
Powell said in a Friday speech in Wyoming that the central bank is ready to tighten again if needed to tame inflation. For investors, it means that reports like the monthly jobs data out next week will be crucial, and that it will be tough to crown a winner in the battle between the bond bulls and bears any time soon, even with Treasuries poised for four straight months of losses.
Powell has “retained maximum policy optionality,” Mohamed El-Erian, chief economic adviser at Allianz SE and a Bloomberg Opinion columnist, told Bloomberg Television.
Read more: In Some Ways, Fed Tightening Is Actually Hitting Hard: Macro Man
The 10-year yield ended the week a bit above 4.2%, after touching 4.36% during the week, the highest since 2007. US Treasuries have lost 1.3% this month through Thursday, leaving them down slightly for 2023, according to a Bloomberg index.
Two Camps
There’s still plenty of debate over how to approach the bond market almost 18 months after the Fed kicked off its tightening campaign.
Some of the world’s biggest money managers, including JPMorgan Asset Management and TCW Group, see an opportunity to boost bullish wagers with benchmark yields probing higher. It’s a camp that expects the Fed’s cumulative tightening and the roughly half-point leap since June in 10-year yields will spark a recession and make rate cuts inevitable in 2024.
Meanwhile, with inflation proving sticky and the US ramping up Treasury issuance, hedge funds are leaning into short bets. And Bill Dudley, the former head of the New York Fed and now a Bloomberg Opinion contributor, says he suspects that “the bond bull market that began in the early 1980s is over.”
Read more: Goodbye to the Bull Market for US Treasury Bonds: Bill Dudley
It’s a backdrop that underscores once again for investors that the economic data will be key to divining the Fed’s course and value in the bond market. Swaps traders are pricing in a roughly two-thirds chance that the central bank will raise its key rate by a quarter-point in November after a likely pause next month.
The first pivotal release comes with data on job creation in August. The median forecast is for a continued cooling in the labor market, which the Fed still sees as too tight. Before they assemble on Sept. 19-20, officials also get a fresh reading on consumer inflation.
“The market has been in a window where data is secondary, and it’s about waiting for September and that starts with the jobs report on Friday,” said Jack McIntyre, a portfolio manager at Brandywine Global Investment Management. At this point, the path of inflation and wages “is a bigger influence than supply on the direction of longer-dated yields.”
Tiffany Wilding, an economist at Pacific Investment Management Co., warned clients this week that “it’s not unthinkable” that the Fed could pause for a while and then hike in 2024 if the consumer and the economy remain resilient.
Another key part of the conversation is that many investors are assessing whether structural forces have changed in the economy such that the Fed’s long-run neutral policy rate has increased. The discussion is another catalyst behind the recent rise in long-term yields.
What Bloomberg Economics Says...
“If the long and variable lags of past rate hikes hit the economy toward the end of this year — when Bloomberg Economics forecasts a recession — the argument that the neutral rate is low could gain traction.”
—Anna Wong, chief US economist
For the full note, click here
“We see the current stance of policy as restrictive, putting downward pressure on economic activity, hiring, and inflation,” Powell said in his speech Friday. “But we cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty about the precise level of monetary policy restraint.”
What to Watch
- Economic data calendar:
- Aug. 28: Dallas Fed manufacturing activity
- Aug. 29: FHFA House price index; S&P CoreLogic CS; JOLTS job openings; consumer confidence; Dallas Fed services activity
- Aug. 30: MBA mortgage applications; ADP employment change; trade balance; GDP; wholesale inventories; personal consumption; Core PCE; retail inventories; pending home sales
- Aug. 31: Weekly jobless claims; Challenger job cuts; personal income/spending: PCE deflator; MNI Chicago PMI
- Sept. 1 : US monthly jobs report; S&P Global US Manufacturing PMI; construction spending; ISM manufacturing/prices paid/employment/new orders; Wards vehicle sales
- Fed calendar:
- Aug. 28: Fed Vice Chair for Supervision Michael Barr
- Aug. 29: Barr
- Aug. 31: Atlanta Fed President Raphael Bostic; Boston Fed President Susan Collins
- Sept. 1: Bostic: Cleveland Fed President Loretta Mester
- Auction calendar:
- Aug. 28: 13- and 26-week bills; 2- and 5-year notes
- Aug. 29: 42-day cash management bills; 7-year notes
- Aug. 30: 17-week bills
- Aug. 31: 4- and 8-week bills
--With assistance from Edward Bolingbroke and Ye Xie.
