Bond investors, once again rattled by robust economic data, now want clear and conclusive evidence that Federal Reserve rate cuts are imminent before making any more big bullish bets.
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(Bloomberg) — Bond investors, once again buoyed by robust economic data, now want clear and conclusive evidence that Federal Reserve rate cuts are imminent before making any more big bullish bets.
U.S. yields rose to their highest level of the year last week after traders were treated to the nasty surprise of a third straight month of stubborn inflation. The market shock was accompanied by a wave of new short positions, causing more investors to become cautious. Weak demand in the Treasury’s recent long-term bond sales was further evidence of bearish sentiment.
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“The shorts now have the Treasury market,” said Andrew Brenner, head of international fixed income at NatAlliance Securities LLC. “We need numbers to support the idea that interest rates need to be lower.”
On Friday, Treasury bonds fell and yields fell as tensions in the Middle East sparked a flight to safety. Iran’s unprecedented attack on Israel on Saturday added to fears – and while any further escalation could create demand for U.S. Treasuries as a haven, the current economic environment is more like one of higher longer-term interest rates and pressure on bonds. Without compelling evidence of change, few investors appear willing to swim against the tide.
After pricing in up to six interest rate cuts in 2024, or 1.5 percentage points of easing, at the beginning of the year, traders now doubt that there will be even half a percentage point reduction. Most Wall Street economists have also scaled back their forecasts, painting a dire scenario for U.S. yields, including a possible repeat of maturity overshoots above 5% like last October.
Read more: Treasuries Haven offering gets a boost from newly added big bond shorts
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The rebalancing of rate cut expectations has been brutal for bonds. U.S. Treasury bonds lost about 0.6% last week and are down about 2.6% year to date, according to a Bloomberg index. That’s a return of more than half of the 4.1% gain in 2023.
Read more: The Fed’s first rate cut won’t happen until December, says Deutsche Bank
Even after Friday’s gains, the 10-year Treasury yield ended last week at 4.52%, with expected buying at the 4.5% level either not materializing or at least not strong enough to withstand the pressure of selling pressure.
“With US disinflation well above the Fed’s 2 percent target for three months now, traders are getting used to the prospect that the ‘last mile’ of disinflation will be difficult to achieve,” said Thierry Wizman, global Currency and Interest Rate Strategist at Macquarie Group. A rise in 10-year yields to 4.75% “doesn’t seem too far-fetched given the current situation,” he added.
Federal Reserve Bank of Boston President Susan Collins said Friday that it may take longer than previously thought to gain confidence to ease monetary policy, reiterating earlier views. A day earlier, New York Fed colleague John Williams said there was no clear need to adjust monetary policy in the near term.
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Read more: Fed Chairman Collins announces two rate cuts this year, no urgency to cut rates
This week, investors will get insight into consumer spending with the latest retail sales report, as well as new data on how the housing market is faring amid still-high mortgage rates. Traders will also analyze earnings from some of Wall Street’s biggest banks, with shares of JPMorgan Chase & Co. falling on Friday after its full-year net interest income outlook fell short of expectations. Citigroup Inc.’s earnings beat analysts’ estimates.
Minutes from the Fed’s March meeting released Wednesday underscore Fed officials’ reluctance to cut interest rates until they have more evidence that inflation is firmly on track to 2%. Consumer prices rose 3.8% in the 12 months to March (excluding food and energy).
Meanwhile, there are growing questions about whether the Fed’s policy is restrictive enough to weigh on the labor market, despite the recent aggressive tightening cycle. Many traders now believe that the so-called neutral interest rate, which neither stimulates nor restricts the economy, is much higher today than it was before the pandemic.
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What Bloomberg Intelligence Says…
“Rates markets have reached new price ranges following the stronger-than-expected March US consumer price report and the still-neutral Federal Reserve meeting minutes. The market is starting to hedge interest rate hikes as the next policy move, but the two-year return may be accounting for more symmetrical outcomes.
— Ira F. Jersey, Will Hoffman, BI Strategists
For the full notice click here.
Derivatives traders expect the key interest rate to hover near 4% in about three years – well above Fed officials’ average forecast of 2.6% for their long-term interest rate.
“It’s possible” that the long-term interest rate is higher now than in the past, the Fed’s Collins said in an interview Friday, adding that she was working with her team on the issue to formulate a clearer view. “That’s what I’m going to focus on because it’s an important question.”
Pressure could be put on Fed Chairman Jerome Powell and other policymakers to at least push through a rate cut shortly before the U.S. presidential election in November because they don’t want to appear political, NatAlliance’s Brenner said. But the steady drip of strong economic data complicates matters. “It’s clear that Powell wants to let up and is looking for cover – but he can’t find it,” he said.
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While many expect the Fed’s upcoming speakers to take a more hawkish tone amid the worrisome inflation trend, some traders are hesitant to put their money behind what officials need to do after all the apparent reversals. For others, there is a palpable sense of déjà vu.
“As long as there is robust data, more questions will be asked about the Fed’s interest rate path,” said George Catrambone, head of fixed income at DWS Americas. “It feels a bit like a return to 2023 – no recession, no landing and you just stay in cash.”
What you should see
- Economic data:
- April 15: Empire Manufacturing; retail sales; company inventories; NAHB Housing Market Index
- April 16: Building permits; start of housing construction; New York Fed services business; industrial production
- April 17: MBA Mortgage Applications; Federal Reserve Beige Book; Net TIC flows
- April 18: Philadelphia Fed Business Outlook; initial claims for unemployment benefits; leading index; Selling existing homes
- April 19: Bloomberg US economic survey for April
- Fed calendar:
- April 15: Dallas Fed President Lorie Logan; Mary Daly, President of the San Francisco Fed
- April 16: Fed Vice Chairman Philip Jefferson
- April 17: Loretta Master, president of the Cleveland Fed; Fed Governor Michelle Bowman
- April 18: Bowman; John Williams, President of the New York Fed; Raphael Bostic, president of the Atlanta Fed
- April 19: Austin Goolsbee, President of the Chicago Fed
- Auction calendar:
- April 15: Invoices for 13 and 26 weeks
- April 16: 42-day cash management invoices; 52 week invoices
- April 17: 17-week bills; 20-year bonds
- April 18: 4, 8 week bills; Five-year tips
– With assistance from Edward Bolingbroke.
(Changes heading. Adds information about Iran attack.)
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