Bond traders brace for wildcard, risk-laden Fed meeting

(Bloomberg) – The risks for bond investors from next week’s Federal Reserve meeting go far beyond officials’ decision to raise interest rates again.

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For a market that is betting the central bank will look to a rate cut soon enough, its updated quarterly forecast for the policy rate and key economic indicators – due to be released Wednesday alongside the rate decision – will be at least as important.

The rate decision is of course key, especially as traders remain divided on the likelihood of a hike in June or July. But there is more straddling the course of politics after this point.

The Fed has been adamant that it’s premature to think about rate cuts this year, and traders aren’t expecting more than one. Still, there are plenty of bets in options and elsewhere that an economic downturn will necessitate lower borrowing costs.

Thus, the economic projections of members of the Federal Open Market Committee and the tone of Chairman Jerome Powell at his post-decision press conference could shape the response more than the timing of the next quarter-point hike. If they suggest conditions are peaking, bets on a pivot would increase, while a more robust and hawkish set of forecasts would incentivize bets on higher rates for longer.

“The market is positioned for a long-lasting rally,” said Meghan Swiber, rates strategist at Bank of America Corp., referring to the part of the market that benefits the most from lower yields, “and the ultimate thing underlying this view is that the Fed is done with the hiking cycle.

Asset managers favoring long-dated Treasuries or positioning themselves for a steeper yield curve are anticipating an end to Fed rate hikes, Swiber said. Bank of America’s latest monthly investor sentiment survey found that US dollar duration exposure is at its highest level since 2004, after eclipsing the pandemic highs of April 2020.

Swap contracts tied to future Fed meetings – which at the end of May almost fully priced in a quarter-point increase in June – brought that result down to about one in three – still an unusual lack of consensus if shortly before the event. The Fed has hiked rates 10 times in a row since March 2022, and in all but two cases, swap pricing left little doubt as to the likely outcome.

The July contract rate, at around 5.31%, is about 23 basis points higher than the 5.08% level of the Fed’s target rate, which almost entirely provides for a 25 basis point increase in here there. For December, the contractual rate is 5.07%, anticipating that any rate increase of a quarter point from the current level will be reversed by the end of the year.

“The Fed is pretty much done even if it goes there once or twice more,” said Arvind Narayanan, senior portfolio manager at Vanguard Group Inc. “Either the economy slows down significantly in a recession that forces the Fed to cut rates, or the economy slows enough to keep rates at 5% for the rest of the year, then the Fed eases slowly next year.

What Bloomberg strategists say

“It is indeed rare for the Fed to tighten policy after a pause. It is even rarer for him to do so when the rates are already restrictive.

— Simon White, macro strategist

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Inflation data to be released early Tuesday could prove decisive. The growth rate of the consumer price index is expected to slow to 4.1% in May from 4.9% and to 5.2% from 5.5% excluding food and energy. The Fed is targeting an average inflation rate of 2% over time.

Citigroup Inc. economists, who expect a rate hike in June, pin that forecast on May CPI readings which they say will show core inflation remaining closer to 5% , said Andrew Hollenhorst, chief U.S. economist at the bank, in a video posted Thursday.

Ahead of the meeting, Treasury market signals could be skewed by an unusually large amount of new compressed supply in two days. In addition to monthly sales of 3- and 10-year notes and 30-year bonds, normally spread over three days, $206 billion in Treasury bills are expected to be sold to replenish government coffers, which have been depleted until the federal debt ceiling. was suspended last week.

Expectations for further Fed rate hikes peaked this year in early March, when Powell said policymakers were ready to reaccelerate the pace of rate hikes if economic data warranted. The yield on the two-year Treasury note, which is more sensitive than longer maturities to changes in Fed rates, briefly exceeded 5%. It stabilized around 4.6% as the case for further rate hikes was undermined by several regional bank failures and other signs that the economy could finally adjust to more financial conditions. strict.

“We think the Fed is more likely to jump in July,” said Thomas McLoughlin, head of fixed income for the Americas in the chief investment office of UBS Group’s wealth management arm. “But Powell’s message has been that his intention is to keep monetary policy tight at least through the end of the year and potentially into next year.”

What to watch

  • Economic Data Calendar

    • June 12: Monthly budget statement

    • June 13: consumer price index; NFIB Small Business Optimism

    • June 14: MBA mortgage applications; producer price index

    • June 15: Retail sales; applications for unemployment benefits; import and export price indices; Manufacturing Empire; Philadelphia Fed Trade Outlook; industrial production; commercial inventories; International Treasury Capital Flows

    • June 16: New York Fed Services business activity; Feeling of the U. of Michigan and inflation expectations

  • Federal Reserve calendar

  • Auction calendar

    • June 12: bills for 26 and 13 weeks; 3 and 10 year notes

    • June 13: 52-week bills; 42-day cash management invoices; 30-year bonds

    • June 14: 17-week bills

    • June 15: 4 and 8 week invoices

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