Bond Traders Betting on a Fed Rate Cut Won't Be Easily Dissuaded

(Bloomberg) -- 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.

U.S. policy makers 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 emphasize 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 U.S. rates strategy at Societe Generale SA. She points out that the economic uncertainties dragging down U.S. yields are global, and foremost among these is weak inflation.

Bond Traders Betting on a Fed Rate Cut Won't Be Easily Dissuaded

Fed funds futures show traders betting the central bank’s benchmark will fall to 2.18 percent 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 percent from more than 2.76 percent 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 percent on the quarter, from 1.8 percent.

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 percent year-on-year increase, still short of the central bank’s 2 percent 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 percent.

Speculation that central bank easing may be on the table has increased in part because of recent comments by policy makers, 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. The median estimate in a survey of analysts surveyed by Bloomberg is for growth of just 1.1 percent year-on-year in the first quarter.

“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.

What to Watch

  • The week’s focal point is the Fed’s policy decision and press conference on Wednesday, with investors also paying close attention to the Treasury’s refunding announcement earlier that day and the jobs release on Friday
  • For U.S. economic releases:
    • April 29: Personal income and spending report, including PCE deflator; Dallas Fed manufacturing gauge
    • April 30: Employment cost index; S&P CoreLogic housing data; Chicago PMI; pending home sales; Conference Board consumer confidence
    • May 1: MBA mortgage applications; ADP employment change; Markit manufacturing PMI; ISM manufacturing; construction spending; vehicle sales
    • May 2: Challenger job cuts; weekly jobless claims; nonfarm productivity and unit labor costs; Bloomberg consumer comfort index; durable goods, capital goods and factory orders
    • May 3: Advance goods trade balance; wholesale inventories; jobs report; Markit services PMI; ISM non-manufacturing gauge
  • It’s a big week for the Fed:
    • May 1: FOMC rate decision and press conference
    • May 3: The Chicago Fed’s Evans makes an appearance in Stockholm, and there will be a cavalcade of officials speaking at the Hoover Institute Policy Conference, including Fed Vice Chairman Richard Clarida, Fed Governor Michelle Bowman, the New York Fed’s John Williams, the St. Louis Fed’s James Bullard, San Francisco’s Mary Daly, the Dallas Fed’s Richard Kaplan and Cleveland’s Loretta Mester
  • Here’s the schedule for Treasury auctions:
    • April 29: $39 billion of 3-month bills; $36 billion of 6-month bills
    • May 2: 4- and 8-week bills

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