After dialing back their expectations for 2024 Federal Reserve interest-rate cuts substantially since the start of the year, bond traders on Wednesday will take their next cue when policymakers release their own updated projections for their benchmark.
Coming on the heels of a consumer price index report that showed higher-than-expected core inflation for a second straight month, there’s a lot riding for the Treasuries market from the Fed’s new so-called dot-plot. The median forecast of Fed policymakers in December showed three quarter-point rate reductions for 2024, and derivatives contracts show slightly more than that priced in as of Wednesday.
The question is whether policymakers maintain that expectation or potentially scale it back in the wake of price increases that remain well above their 2% inflation target.
Bank of America Corp. strategists warn it would take only only two officials to switch to two cuts for the median dot to move higher — something they see as a spur to Treasury yields. Benchmark 10-year yields already hover at around 4.2%, well above where they ended last year.
“The market is really sensitive now to any changes in the dot plot,” said Meghan Swiber, Bank of America’s director of US rates strategy. “Everyone is looking at all the recent the data and wondering about how it is going to play out with regard to potentially impacting officials’ quarterly forecasts and the Fed’s decision-making overall.”
The Fed is expected to keep rates unchanged at the March 19-20 meeting for the fifth straight gathering, with policymakers not yet telegraphing confidence inflation is headed toward sustaining their 2% target. Tuesday’s CPI figures showed the core gauge, which excludes volatile food and energy prices, rose 0.4% for a second month, for the biggest back-to-back monthly rise since last May.
The 2024 median Fed forecast isn’t the only focus next week. Investors including Michael Kelly at PineBridge Investments will also be eyeing the scope of easing projected for next year.
Last time, policymakers anticipated a full percentage point of cuts in 2025. That was before US growth outperformed last quarter, with a continued above-trend GDP gain now seen for the start of 2025.
“The real issue to us is not if it’s two or three cuts this year, but if there’s actually any at all next year” given the likelihood of a soft landing, said Kelly, global head of multi-asset at PineBridge, which manages about $157 billion in assets.
The ‘Belly’
Kelly said he and his colleagues took profits on long-term government debt holdings in January after a sharp rally the prior two months, are currently overweight stocks versus targets and expect the dollar to appreciate. He sees risks for medium-term Treasuries — the so-called belly of the curve — in the event of a soft landing, where inflation comes down to 2% without a major economic downturn.
Still, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon this week warned about baking a soft-landing into the outlook. He said he wouldn’t take the prospect of a recession in the US “off the table.” The Fed typically slashes rates quickly and deeply in recessions.
While Fed Chair Jerome Powell often plays down the dot plot, telling lawmakers this month that it’s “not a plan.” But it’s also proved an aid on occasion, such as last June, when policymakers refrained from hiking rates but the dot plot showed more to come later in 2023 — helping avoid any burst of investor exuberance over the tightening cycle being over.
What Bloomberg Intelligence Says...
“The market’s fixation on when the Fed’s rate-cut cycle may begin is unlikely to be clarified at the March 20 Federal Open Market Committee meeting. The median ‘dot’ may show one fewer cut this year, but the same level for the federal funds rate at end-2025.”
— Ira F. Jersey and Will Hoffman, BI strategists
The projections also include an estimate for the policy rate over the “longer run,” viewed as something of a proxy for their gauge of the “neutral” rate, or the stance that neither spurs nor slows the economy. Fed policymakers’ median for that has been held at 2.5% or lower since before the pandemic.
Former Treasury Secretary Lawrence Summers warned last week that’s way too low for neutral. A paid contributor to Bloomberg TV, he said neutral is more likely at 4% or higher versus being less than 3%. And that suggests today’s setting isn’t as restrictive as the Fed may think, he said.
If policymakers shifted their long-run estimate higher next week, that’s another risk to Treasuries, market watchers said. Investors that, over the past year, the average of participants’ projections has been creeping higher. Swaps traders, for their part, already are wagering the benchmark rate will be well above 2.5% in a few years’ time.
Alongside that upward tilt: a steady climb in US federal borrowing that threatens to put pressure on longer-term yields. A 10-year Treasury auction on Tuesday showcased what investors characterized as mediocre demand, amid enlarged issuance sizes.
This all “points to long-term rates staying anchored at higher levels,” Jay Barry, co-head of US rates strategy at JPMorgan, said at a webinar this month on the rising federal debt burden.
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