Bond Market Euphoria Shifts to Debate Over How Low Fed Will Need to Go

(Bloomberg) — A torrid rally in the bond market shows traders are convinced the Federal Reserve’s rate-hiking cycle is over. The debate now centers on when central bankers will start cutting spending, and to what extent.

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The question is whether the economy is poised for a soft landing or whether it is heading into a worse spiral. Both scenarios suggest rate cuts are coming, perhaps as early as March. Current market expectations are for an easing of at least 1.25 percentage points next year, a trend that appears to pave the way for lower yields and a prolonged recovery.

This does not rule out new episodes of volatility. Conflicting data could raise doubts, and Fed officials will likely continue to remind the market that they are in no rush to ease policy. At the end of a big week of Fed speeches before the start of a customary pre-meeting communications blackout period, Chairman Jerome Powell said Friday that while policy was largely in restrictive territory, he was ” premature” at this point to speculate on when the policy might be relaxed. His reaction didn’t stop bond traders from pushing the market even higher.

U.S. Treasuries may have moved too quickly and traders got burned before prematurely betting on a pivot. But there is a sense that yields have peaked for the cycle and that the data slowdown will at some point force some of the nearly $6 trillion in record cash held in money market funds into yields in the Longer-term Treasury above 4%. Even after a 60 basis point drop last month, benchmark Treasury yields remain significantly higher than the lows set earlier this year, when recession fears were stoked by U.S. bank failures.

“The Fed has ratified the market moves by saying that the data has softened, which has reassured the market and that they tend to settle for narratives and go a little too far,” said Michael Cudzil, manager portfolio at Pimco. “It’s also possible that the data slowdown is something more nefarious.”

The story continues

An avalanche of data next week will test the mettle of bond bulls, culminating with the latest US jobs report. Economists surveyed by Bloomberg expect a rebound in hiring in November, to 200,000 from 150,000 the previous month, as strikers return to work. The unemployment rate is expected to remain at 3.9% while wages are expected to slow slightly to an annual rate of 4%.

With inflation falling faster than central bank officials expected, it reinforces the sentiment “that the Fed’s last rate hike was in July,” said Kelsey Berro, fixed income portfolio manager at JPMorgan Asset. Management, at Bloomberg Television. Although yields can rise on any given day, “we could go down a lot if next year we’re looking at rate cuts.”

Looking ahead, upcoming U.S. consumer inflation data and the start of the Fed’s final two-day meeting of the year are the next hurdles beyond the jobs report. The way the Fed sets its outlook for rate policy through next year and 2025 via its dot-plot could inject some uncertainty into a market that has run ahead of the central bank’s current forecast by a half-point easing over the next 12 months. .

“You may disagree with the magnitude, not the direction, of the decline in Treasury yields,” said Pimco’s Cudzil. “A 10-year yield of 4.25% or 4.5% is historically attractive over the long term. »

What Bloomberg Economics says…

“Our scenario is that unemployment is expected to rise persistently in 2024, approaching 5% by the end of the year – a mild recession by historical standards. We believe the Fed will have enough clarity on the economic slowdown to cut rates for the first time in March 2024. The Fed will likely cut rates by a total of 125 basis points in 2024 and an additional 125 basis points in 2025.”

— Anna Wong, Eliza Winger, Estelle Ou and Stuart Paul, BE economists

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For much of the year, the bond market and investment returns were held back by expectations that the Fed would maintain its “higher for longer” interest rate policy or be forced to come back and increase borrowing costs. Now the Treasury market senses a clearer path forward. Did he get ahead of himself?

Mark Dowding, chief investment officer at London-based RBC BlueBay Asset Management, says he expects yields to rise in the coming weeks after investors “indulged in yields” in November.

“After being constructive on duration in early November, we took profits as yields fell, and over the last week we moved to a short position,” Dowding said.

Data this week showed that the core personal consumption expenditures price index, which excludes the volatile food and energy components, rose in October on an annual basis by 3.5%. Although this Fed-favored indicator of underlying inflation is moving in the right direction, Dowding says the Fed likely won’t cut rates until they’re below 3%, which RBC BlueBay doesn’t expect occur before the second semester.

“We consider the market to be premature with the Fed,” he said.

What to watch

• Economic data :

  • December 4: factory orders; durable goods orders; capital goods orders

  • December 5: US services S&P Global, composite PMI indices; Jolts job offers; ISM Services Index

  • December 6: MBA mortgage loan applications; ADP employment; non-agricultural productivity; unit labor costs; trade balance

  • December 7: first unemployment registrations; Job cuts at Challenger; wholesale and inventory; Consumer credit

  • December 8: Nonfarm payrolls, including unemployment rate and wage growth; University of Michigan Consumer Confidence and Inflation Expectations

• Fed Timeline:

• Auction schedule:

  • December 4: invoices from 13 to 26 weeks

  • December 5: cash management invoices at 42 days

  • December 6: 17-week bills;

  • December 7: invoices 4 to 8 weeks

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