The world’s biggest bond market got the ammo it needed from a below-forecast consumer price figure to fully lock in a Federal Reserve downshift in their policy-rate tightening pace, though not enough to wave an all clear sign for Treasuries.
Treasuries surged Tuesday as a surprise below forecast pace November CPI growth triggered swaps traders to lay out a more tempered trajectory ahead that puts the peak Fed policy rate in this cycle solidly below 5%. While that implied a notch down to a 50-basis point hike from the Fed when they wrap their two-day meeting Wednesday and smaller bumps thereafter, investors warns it doesn’t put the US central bank on course for cutting rates thereafter.
“The Fed has ample room to decelerate the pace of hikes,” said Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments. “It gives them room to stop hiking early next year but they are still going to want to send the message that they are going to want to hold rates – as opposed to signaling cuts that the market’s got priced in,” given inflation the Fed gauges remains several times above the central bank’s target.
Five-year Treasury yields tumbled in as much as 24 basis points to 3.55%, pushing the rate to the lowest level since Sept. 13. Longer-maturity yields declined less, causing the Treasury curve to become less inverted. That sharp steepening move in the curve may be tempered as the Fed likely indicates they will remain vigilant on inflation and maintain a hiking stance, albeit at a slower pace.
Fed Chairman Jerome Powell has also said last month that officials’ new estimates on the trajectory of policy, released Wednesday, will show a higher path for the funds rate. He also has stressed that rates will have to stay high for “some time” eve as the bond market has priced in rate cuts for the second half of next year and into 2024.
In September the median Fed official forecast put the funds rate at 4.4% at the end of this year and 4.6% a year later. Some economists forecast the 2023 median rate will be boosted to 5.1%. The CPI figure has rates markets seeing a better probability that it is moved up only to 4.875%, according to Blake Gwinn, head of US rates strategy at RBC Capital Markets.
The CPI data drove swaps traders to price in that the central bank’s policy rate will peak in May at 4.85%, down from around 4.99% before the release and from well over 5% a few month ago. By December 2023, traders see the Fed pushing the funds rate down to around 4.35% — representing about a half-point worth of policy easing by the end of 2023.
Still there is a sense among bond investors that the rally has run too far. Once January arrives and traders start the new year, some back up in yields makes sense with the outlook for the economy and inflation remaining uncertain,
“Our bias is to fade this rally and look to how people position in early January,” said John Madziyire, portfolio manager at Vanguard. “The return of inflows for bond funds means there has been more comfort in adding duration,” with the ensuing rally in Treasuries gaining speed from bearish investors “closing out trades into year end”.
Once January arrives and traders start the new year, some back up in yields makes sense with the outlook for the economy and inflation remaining uncertain, Madziyire said.
Related story: Fed Swaps Lean Toward a 25bp Hike Downgrade by February Meeting
Unusually, the decline in yields began about a minute before the Labor Department’s release of November CPI data at 8:30 a.m. in Washington, and continued afterward. The monthly advance was the smallest in more than a year, indicating that inflation is receding in the face of the Fed’s most aggressive monetary policy tightening in decades.
“Investors should be careful not to over-extrapolate these results and temper their expectations for a premature pivot from the Fed,” Jason Pride, chief investment officer of Private Wealth at Glenmede said in a note. “Consumer inflation is still far from the Fed’s price stability goals, and the 1970s provide case-in-point as to the risks of claiming victory on inflation too early. The Fed will likely need to keep monetary policy on a restrictive footing into the new year.”
The gains benefited those who bought Treasuries in Monday’s auctions, when new 10-year notes were sold at a yield of 3.625%. The notes richened to nearly 3.41% Tuesday. An auction of 30-year bonds slated to be sold at 1pm New York time yielded around 3.46% in pre-sale trading, down from 3.54% before the CPI data.
Sovereign debt outside the US was also rallying amid global hopes that the worst of price pressure that plagued markets this year maybe in the rear view mirror.
German bonds surged sending benchmark 10-year government borrowing costs sliding 8 basis points to 1.86%, the biggest drop in a week. Traders eased bets on how far the European Central Bank will raise interest rates, pricing the deposit rate to peak at 2.88% by June, a 8 basis points drop since Monday.
Gilts erased declines but money markets kept Bank of England wagers steady, betting the bank rate will rise to 4.73% by August.
While share prices also rallied Wednesday, the asset classes losses combined with those in bonds has caused investors in the popular 60/40 split between equities and high-quality bonds to lose around 15% this year, according to a Bloomberg index. The S&P 500 jumped as much as 2.8% and the tech-heavy Nasdaq 100 rose as much as 3.9% before paring gains.
The sharp slide in rates since the end of October has netted bond holders gains in November of about 2.7% and helped offset what has been a historic year of losses for invetsors. The Bloomberg US Treasury index has lost over 11% this year through Monday.
“This whole year has been one hope trade in both equities and fixed income markets,” said Jason Bloom, head of fixed income, alternatives, and ETF strategies at Invesco, warning that yields are vulnerable to backing up should the Fed’s efforts at taming core inflation prove “a much longer, harder fought battle” that some now are speculating.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
Read more articles by Liz Capo McCormick, Michael MacKenzie
