Bond traders have firmed up bets that the Federal Reserve will cut interest rates this year and it’s hard to imagine what officials could say at next week’s meeting to dispel that conviction.
US policymakers have gravitated in recent months toward a more dovish outlook. They have been following — but never quite managed to catch up with — market pricing that is now pointing toward a reduction this year.
Treasuries rallied in the past week even as stocks surged and Friday’s stronger-than-expected economic growth reading failed to halt that momentum. Traders looked beyond the stellar headline number to the details on growth and softening inflation measures, and simply priced in more easing. That suggests it may take a lot more than reassurances on growth from the Federal Open Market Committee on Wednesday or a strong payrolls number on Friday to change the market narrative.
“The Fed could emphasise the positives on the economy, but I’m just not sure how they can meaningfully move the needle on the rates market,” said Subadra Rajappa, head of US rates strategy at Societe Generale SA. She points out that the economic uncertainties dragging down US yields are global, and foremost among these is weak inflation.
Fed funds futures show traders betting the central bank’s benchmark will fall to 2.18 per cent by the end of 2019, more than a quarter point below the current fed effective rate. The 10-year Treasury yield, meanwhile, has fallen to just below 2.50 per cent from more than 2.76 per cent in early March.
Inflation is half the Fed’s mandate, and given the risk of falling short on that, the Fed may well err on the side of dovishness at its upcoming gathering. Friday’s gross domestic product report showed one key inflation measure dropped to 1.3 per cent on the quarter, from 1.8 per cent.
That’s sharpened investors’ focus on Monday’s personal income and spending report for March. It will include a reading for the Fed’s preferred inflation gauge, with consensus around a 1.6 per cent year-on-year increase, still short of the central bank’s 2 per cent goal. Wage numbers in the employment report will also be in focus later in the week, with survey estimates putting year-on-year pay growth at around 3.3 per cent.
Speculation that central bank easing may be on the table has increased in part because of recent comments by policymakers, including Chicago Fed President Charles Evans, who is a voter on the FOMC, and Dallas Fed boss Robert Kaplan.
Still, the easing currently priced into the market is pretty aggressive, by some accounts. Janus Henderson Group Plc’s Nick Maroutsos, who is buying short-dated Treasuries, said in a Bloomberg Television interview Friday that although he does see the Fed’s next move probably being a reduction, that’s unlikely to happen until late 2020. Goldman Sachs Group Inc. economists, on the other hand, wrote in a note that they expect the Fed’s next action on rates is still more likely to be a hike, although they don’t see that happening until the final quarter of 2020.
For Columbia Threadneedle strategist Ed Al-Hussainy, the biggest risk to his bullish stance on Treasuries would be a break in the clouds hanging over international markets. He’ll be paying close attention to the Euro-area gross domestic product report on Tuesday.
“European GDP has room to surprise to the upside — expectations are low,” he said. But he’s not counting on it. “I don’t see enough evidence that Chinese stimulus is spilling out to the rest of the world.”
In addition to the broader macroeconomic picture, traders will be on alert for any hints of fine-tuning to the Fed’s excess reserves rate. The Fed could also provide more projections on balance sheet composition and the Treasury Department will outline auction plans at Wednesday’s quarterly refunding announcement.