This week, the US bond market faces its own Super Tuesday of sorts: the release of fresh inflation data investors will use to predict when the Federal Reserve will start cutting interest rates.
Following a somewhat mixed jobs report on Friday, investors see the upcoming February Consumer Price Index report, or CPI, as crucial to deciding whether to add to bullish Treasury wagers. Swaps traders see an interest-rate reduction beginning in June as a virtual lock, with nearly four quarter-point cuts expected over the coming year.
The figures will provide a key check on whether inflation is coming down steadily enough to allow the Fed to start easing policy as soon as traders currently expect. A stronger-than-anticipated jump in consumer prices could derail the bond market’s recent rally, which has been fueled by confidence that the Fed is on the verge of pulling inflation back to its target.
That was the case last month, when the CPI triggered a market selloff. The impact may be stronger this time because it’s the last major piece of economic data before the Fed’s March 20 meeting. And Fed officials won’t be providing any guidance, given the traditional pre-meeting blackout on public remarks.
Because of this, the shape of Fed policy to come hinges largely on Tuesday’s data.
“It’s really going to be what the monthly inflation prints are,” said Charlie Ripley, senior investment strategist for Allianz Investment Management.
The selloff in February, which pushed Treasury yields to their highs of the year, was due in part to January’s hot consumer price data, which showed surprising strength in core services, an area of concern for the US central bank.
Since then, traders have once again stepped up their rate cut bets as economic data reinforced the view the Fed may be able to start lowering interest rates later this year. Swaps contracts currently imply around 98 basis points of cuts by the end of 2024, from less than 75 basis points last month. Since hitting a high of 4.47% in late February, yields on two-year Treasuries, which are sensitive to Fed policy, have retreated about 25 basis points. Ten-year yields also declined from last month’s peak.
Speaking before the Senate Banking Committee on Thursday, Federal Reserve Chair Jerome Powell said the central bank needs more confidence that inflation is moving sustainably back to 2%. “When we do get that confidence — and we’re not far from it — it’ll be appropriate to begin to dial back the level of restriction,” he said.
Allianz’s Ripley said the firm entered 2024 expecting 10-year yields to swing between 3.75% to about 4.25% in the near term. When rates earlier this year jumped above that peak, his firm found the securities “pretty attractive.”
Because of the Fed’s customary blackout period ahead of its upcoming March 19-20 policy meeting, economic data will prove pivotal in shaping traders’ expectations. Meanwhile, fresh supply may also influence investor sentiment. The US Treasury department will sell a combined $61 billion in 10- and 30-year debt through auctions on Tuesday and Wednesday.
Kevin Flanagan, head of fixed income strategy at Wisdom Tree Investments, said CPI will be more significant to bond investors than it ultimately is for Fed policy. That’s because while the Fed targets the price index for personal consumption expenditures, or PCE, the market will react to CPI since it’s the first out of the gate.
He explained that while the central bank currently sees a 2.8% core PCE rate, it likely wants it to come down to 2.5%. “When you look at the calendar, that means a couple more reports and that takes you to June,” he said. “But the bond market is not going to wait for core PCE and it will respond to CPI and that will determine whether the rally continues,” he added.
On an annual basis, Bloomberg Economics expects headline and core inflation to come in at 3.1% and 3.7%, respectively. They expect Feb. CPI inflation to rise to 0.4% versus the prior month, up from the 0.3% gain in January, while core inflation will likely slow.
Beyond CPI, traders are awaiting the Fed’s next update to their quarterly rate forecasts, known as the dot plot, set to be released at the completion of the March meeting. In December, Fed officials pencilled in three quarter-point interest rate cuts for this year. The central bank has held interest rates at a two-decade high since July, with their target rate range at 5.25% to 5.50%.
What Bloomberg Strategists Say...
“Next week’s inflation data and the Fed’s dot plot the following week will uncork a lot more volatility.”
“The Fed’s expected loosening of policy is predicated on the premise that its benchmark rate needn’t be so restrictive — as opposed to accommodating a weaker economy — so a lot more will be riding on next week’s inflation numbers” versus the February job creation figures.
— Ven Ram, cross-assets strategist
Heading into next week, “CPI would need to be off the charts” to deter the view that “2024 is actually not opening up as strong as some feared and that January strength was not indicative of reality,” said George Goncalves, head of US macro strategy at MUFG. “This is a bond market that wants to run.”
What to Watch
- Economic data:
- March 11: New York Fed 1-year inflation expectations
- March 12: NFIB small business optimism; Consumer price index; real average earnings; monthly budget statement;
- March 13: MBA mortgage applications
- March 14: Retail sales; producer prices; initial jobless claims; business inventories;
- March 15: Empire manufacturing; import and export price index; industrial production; capacity utilization; manufacturing (SIC) production; U. of Mich sentiment and inflation expectations
- No Federal Reserve speakers slated during self-imposed quiet period ahead of March 20 rate decision
- Auction calendar:
- March 11: 13-, 26-week bills; 3-year notes
- March 12: 42-day cash management bills; 10-year note re-opening
- March 13: 17-week bills; 30-year bond reopening
- March 14: 4-, 8-week bills
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