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Bond Market's Fed Rate-Cut Consensus Has a Skeptic at Vanguard

Bond Market's Fed Rate-Cut Consensus Has a Skeptic at Vanguard

(Bloomberg) -- Bond investors wary of the consensus that the Federal Reserve is on the brink of a rate cut have company over at Vanguard Group Inc. Policy makers aren’t about to take the plunge, says Anne Mathias, a strategist at the world’s second-largest asset manager.

“It’s almost like the market is forcing the Fed to act and that’s just a very weird environment,” she said during a panel at the Fixed Income Leaders Summit in Philadelphia this week. “I don’t think the Fed is going to respond to being forced.”

Mathias is a global rates and currency strategist for Vanguard, which manages $1.6 trillion in fixed-income assets. She’s withholding any conviction on lower rates until at least next week’s Group-of-20 meeting. The U.S. and Chinese leaders are scheduled to meet, and some investors hope the exchange could smooth the path toward a trade deal.

Trade concerns aside, she says the post-Fed rally that drove the 10-year yield below 2% for the first time since 2016, and market pricing for more than a quarter-point rate cut in July, doesn’t fit with the current economic expansion.

Bond Market's Fed Rate-Cut Consensus Has a Skeptic at Vanguard

“It’s hard to come up with a justification for 10-year yields below 2% in my opinion right now,” she said. The post-Fed slide in the benchmark long-term rate is “an overreaction to what’s happening in the economy.”

Ahead of the Fed’s meeting this week, some traders saw the potential for a constructive G-20 meeting as grounds for the Fed to stay patient. But many subsequently abandoned that caveat based on the Fed’s lowered rate projections, and Chairman Jerome Powell’s assurance that policy makers are ready to “act as needed.”

No Need

For Mathias, those last two words are important. The economy isn’t showing much sign of needing the Fed, in her view, with growth still solid and unemployment at 3.6%, the lowest in decades. She also pushed back on the notion -- expressed on the conference panel -- that the 10-year could be headed to 1.5%. That’s below consumer-price inflation, and a negative real rate isn’t warranted in this growth environment, she said.

Others expressed surprise, but not disbelief, at the Fed’s apparent readiness to ease. Leslie Falconio at UBS’s private wealth management arm said the growth and business climate doesn’t worry her, but by lowering rates now the Fed can sustain the economic expansion.

“Excesses normally cause recessions, and we’re not seeing that yet,” with corporate profits likely to strengthen from here, said Falconio, senior strategist at UBS Global Wealth Management’s chief investment office, which oversees the investment strategy for $2.3 trillion in assets.

The wealth manager this week switched its call from no change in rates this year, to a half-point easing in July. Falconio said that progress at G-20 or robust second-quarter growth are risks to that view.

Her multi-sector portfolios carry long-dated positions in Treasuries as hedges against equity volatility. She’s now looking for a steeper curve, led by a sell-off in the 10-year sector as Fed easing would buoy the growth outlook.

Getting Steeper

Mathias said steepening is possible even without Fed action.

“It’s no surprise that everybody’s been talking about the steepener as a favorite trade,” she said on the panel.

In her view, the curve will steepen in two of three potential scenarios. If the economy picks up, inflation expectations start to rise and the Fed continues to stay on the sidelines. Then selling should drive yields higher led by the long end.

In a darker scenario, declining short-end yields would lead the steepening, if the Fed has to cut in response to an equity-market slump or other shock. The steepener trade won’t pay off, however, if the Fed is slow to act to avert a brewing recession, and the prospect of a policy mistake that crashes the economy leads investors to pile into long-dated Treasuries.

“But this Fed has told us they’re going to act very quickly in response to real economic stress,” Mathias said.

To contact the reporter on this story: Emily Barrett in New York at ebarrett25@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Vivien Lou Chen

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