Bond Rout Eases, Thanks to Key Inflation Readings
“The Fed is on hold. Investors feel a little reprieve that [inflation data] didn’t come in higher, which could make people start thinking about a rate-hike scenario.”
A selloff in U.S. Treasuries paused on Friday, bringing yields down from their highest levels of the year, after a report on inflation allayed concern about a spate of hotter-than-expected price data.
U.S. yields declined as investors interpreted the latest reading of the Federal Reserve’s preferred gauge of inflation to support at least one interest rate cut by the end of the year. The two-year rate, more sensitive than longer-maturity tenors to changes by the Fed, retreated back below 5 percent, while the 10-year yield fell as much as 7 basis points (bps), to 4.63 percent.
“It’s a little relief rally,” said Michael Contopoulos, head of fixed income at Richard Bernstein Advisors, noting the small scope of the move. “Investors need to wake up to the idea that inflation is sticky and the Fed won’t be cutting anytime soon,” he said. “In fact, the better question to ask: Is it time to discuss a hike?”
Traders are increasingly cheering any indication that the central bank will be able to cut at all this year, with some speculating that a hike could be next, after a string of sticky inflation reports prompted Wall Street to curb bets on aggressive easing. Earlier this week, the market scrapped some of its remaining wagers, no longer fully pricing in a 25 bps reduction before December. Meanwhile, Citigroup Inc. revised its forecast to predict fewer cuts.
Despite Friday’s rally, a gauge of Treasuries is poised to slump for a fourth week—its worst run since October—and benchmark 10-year yields are headed for a fifth week of increases. Investors are stomaching a loss of more than 3 percent this year.
That’s prompted traders to ramp up bets on further declines. Futures open-interest data suggest that traders set new short positions—wagers on higher yields—in the wake of Thursday’s GDP data; these bets increased the potential for a market rally in response to supportive events or data.
Friday’s March personal income and spending data included price deflators that rose in line with expectations from February levels, while the 2.7 percent year-on-year rate continued to exceed the central bank’s 2 percent target. Excluding volatile food and energy components, the so-called core personal consumption expenditures (PCE) index rose 0.3 percent from the previous month.
“We can expect volatility, but the narrative stays the same: The Fed is on hold,” said Charles Ripley, senior investment strategist at Allianz Investment Management. “Today’s data probably doesn’t change the narrative that’s been forming. Investors feel a little bit of a reprieve that it didn’t come in higher, which could cause concern and make people start thinking about a rate-hike scenario.”
A pause in the selloff is likely to be short-lived, with the Fed due to meet next week. While policymakers are expected to keep borrowing costs steady on May 1, investors will look to Fed Chair Jerome Powell’s press conference for indicators of future policy moves. Just last week, yields jumped after New York Fed President John Williams mentioned the mere possibility of an interest rate increase.
Complicating the calculus, the U.S. Treasury will also announce its planned slate of debt issuance for the coming quarter that day.
“There’s both a story here about the economy holding up very well with high interest rates, as well as inflation pressures being persistent,” Bruce Kasman, chief economist at JPMorgan Chase & Co. told Bloomberg Television following today’s data. “The case for Fed easing here is pretty small anytime soon. Certainly, the Fed is going to have to change its tune about its view that there’s a fair amount of easing that’s coming down the road.”
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