Bond traders are left to debate Fed pivot as rate-cut bets grow

Gene Tannuzzo at Columbia Threadneedle Investments, for one, is on board with the market’s stance, amid slowing global growth and tame inflation. Michael Collins of PGIM Fixed Income, on the other hand, isn’t ready to rule out a rate hike this year, especially after signs of strength in economic data Friday.

The showdown between the two camps may persist with key economic data still delayed because of the lingering effects of the government shutdown. That means appearances by Fed Chairman Jerome Powell and other policymakers may loom large in the days ahead as investors parse their comments for signs officials view the market as leaning too far toward easing.

“It will be interesting to hear the Fedspeak in the next few weeks,” said Tannuzzo, deputy global head of fixed income. “They need to clarify the risks to US growth from the foreign slowdown. This has not been clear so far.”

Benchmark 10-year Treasury yields fell as low as 2.62 per cent on Thursday, the day after Powell said the case for further rate hikes has weakened. However, a one-two punch of stronger-than-anticipated US payroll and manufacturing figures sent 10-year yields back to 2.68 per cent on Friday. Traders now see a steady Fed in 2019 and about 15 to 20 basis points of easing next year; a week ago, futures indicated some chance of tightening in 2019.

‘Shock’ Ahead?

Friday’s data help explain why Collins finds it premature to discount the possibility of additional tightening in 2019, which in his view sets up markets for “a bit of a shock.” Continued strength in consumer-focused reports such as retail sales could prompt policymakers to press on with their projected hikes, according to Collins, whose firm manages $729 billion.

“The consumer’s in good shape,” said Collins, a senior portfolio manager. “Data will continue to be supportive of the markets, of the economy, and probably put a little pressure on the front end of the yield curve.”

Tannuzzo isn’t so sure. For him, a more likely scenario is that slowing US growth and subdued inflation will further erode expectations for another hike. Indeed, Friday’s jobs report showed little sign of wage pressures — despite the headline beat, average hourly earnings rose 0.1 per cent on a monthly basis, versus an expected 0.3 per cent increase.

“The question is, did we see the last hike in December 2018? We think those odds are growing,” Tannuzzo said. “If inflation expectations keep drifting lower, the Fed will have trouble restarting hikes.”

He’s keeping an eye on the data for signs of a slowdown, and he expects reports such as retail sales and personal income will likely “get worse before they get better.” And outside the US, potential spillover effects from US-China trade friction will likely impede tightening, he said.

That fraught geopolitical backdrop — combined with concerns about the global economic outlook — stand to intensify bond traders’ focus on Fed officials.