(Bloomberg) — Bond traders struggling to predict how high the Federal Reserve will raise interest rates are finding the way down is just as troubling.
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At TCW Group Inc., Jamie Patton, co-head of global rates, believes that even the rapid easing currently baked into financial markets does not go far enough, leaving shorter Treasuries to keep the rally going. “Feed will have to lower rates faster and more aggressively than what the market is priced in,” she said.
At JPMorgan Asset Management, Bob Michele sees it differently. He’s betting that the bond market has been running too far behind the Fed as the economy continues to grow — albeit more slowly. As a result, they prefer corporate bonds — which yield higher payouts — over Treasuries. “I don’t see anything broken,” he said.
Differing views are amid what is at stake for investors as the US central bank is almost certain to start cutting interest rates for the first time since 2020 at its September 18 meeting. That prospect alone has sent bond prices soaring as traders scramble to get ahead, raising the risk that markets will be further disrupted by a post-pandemic economy that continues to surprise Fed and Wall Street forecasters with its resilience.
On Friday, the Labor Department’s employment report underscored the uncertain outlook. Employers expanded payrolls at a slower-than-expected 142,000 pace in August, posting the weakest three-month job growth since mid-2020. next month.
Traders still give the Fed the highest chance of cutting its target rate – currently in the range of 5.25% to 5.5% – by a quarter of a percentage point this month, although those at Citigroup Inc. and some other banks bet on a move of half a point. By mid-2025, the swap market will be cut to around 3%, roughly at a level that appears to be neutral for economic growth.
But the Fed’s trajectory has repeatedly blindsided traders since the pandemic. Expecting that the spike in inflation would be brief, he did not anticipate how high the rate would be. Then they prematurely piled into the bet that was poised to reverse the course, leaving them hit by a new round of losses when not.
That sowed some doubts whether bond prices have again risen too far. The two-year Treasury yield, which tracks the Fed’s key policy rate, has fallen to around 3.7% from more than 5% in late April – enough to account for five Fed moves of a quarter point. Lower borrowing costs have also filtered down to corporate bonds and stock prices, easing financial conditions without action from the Fed.
“The Fed has to cut, we all know, but the question is the pace,” said John Madziyire, senior portfolio manager at Vanguard, which manages $9.7 trillion in assets. He said the company had used a “tactical short bias” into the bond market since the rally.
“If the Fed becomes aggressive and starts to cut 50-basis-points,” he said, “making financial conditions more loose, then we have the risk that we get another acceleration of inflation.”
However, so far, inflation has been headed in the right direction: On Wednesday, the Labor Department is expected to report that the consumer price index rose 2.6% in August from the previous year, according to the median forecast of economists surveyed by Bloomberg. This would be the smallest increase since 2021. There will be new guidance from Fed officials, which is in the traditional blackout period before the September 17-18 meeting.
The bank’s trajectory will depend on whether the Fed pulls the economy into soft bankruptcy or is forced to switch to recessionary warfare mode, as it did during the Wall Street credit crisis or after the collapse of the Internet bubble. For now, economists are generally predicting that the economy will avoid a contraction, keeping stocks not far from record highs despite the recent slump.
What Bloomberg strategists say:
“There is very little chance the Federal Reserve will cut 50 basis points on September 18 based on 4.2% unemployment. But two-year yields are down. So if the price for Treasury yields is up to two years is very rich and we’ll see them go up from here when the reality sets in.”
– Ed Harrison, macro strategist
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JPMorgan’s Michele, chief investment officer for global fixed income, expects that the Fed will only need to cut its benchmark by 75 to 125 basis points, seeing parallels with what happened in the mid-1990s. At that time, the economy continued to grow despite the central bank doubling interest rates to 6%, which was only slightly lower.
“There is only one soft landing that we can all agree on and that was 1995,” he said. “I see a lot of parallels with this time.”
At Nuveen, Saira Malik, chief investment officer, is also skeptical about how far the market has run before the Fed. That has led Treasuries to gain over the past four months, marking the longest winning streak since 2021, before the start of the Fed’s rate hikes.
But he thinks the market is ripe for disappointment. “The Fed will be slower than faster because the economy is not in recession,” he said, predicting the 10-year yield could rise again to 4% from around 3.7% today. “Treasury has moved a little too far, too fast.”
What to Watch
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Economic data:
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September 9: Grocery Inventory; New York Fed 1-year inflation expectations; consumer credit
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September 10: NFIB’s small business optimism
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September 11: MBA mortgage application; consumer price index; real average earnings
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September 12: producer price index; unemployment claims; changes in household net worth; monthly budget statement
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September 13: Import and export price index; University of Michigan sentiment/current situation/expectations
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Food calendar:
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Auction calendar:
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9. September: 13-, bill 26 weeks
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September 10: 42-day cash management bill; 3 year note
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September 11: 17-week bill; 10 years of reopening records
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September 12: 4-, 8-week bill; The 30-year bond reopened
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–With assistance from Kristine Aquino and Ye Xie.
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