Bond Market Embraces Stability Before Series of Chaotic Events
The gap between the two- and 10-year yields has widened from 4 basis points at the start of October to 17 basis points.
(Bloomberg) -- Traders seem to have finally warmed to the idea that the Federal Reserve’s likely interest-rate cut on Wednesday will be its last for some time.
The central bank is widely expected to lower its target policy rate a quarter-point next week to 1.50%-1.75%. That would be the third in a series of cuts that Chairman Jerome Powell has described as a “midcycle adjustment” to extend this historic economic expansion. He’s had a tough time selling that plan to rates traders, who’ve consistently bet on easier policy than the Fed has signaled all year.
But over the past few weeks -- and even under the shadow of a potentially chaotic month-end -- traders have pared wagers on more aggressive cuts and ditched hedges against volatility. Waning activity in eurodollar futures suggests traders are more inclined to embrace the stability in rates for now. That reflects diminished fears of a collapse in negotiations over U.S.-China trade and the U.K.’s exit from the European Union.
“We’ve seen a mood switch to optimism on Brexit, optimism on the trade front,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale. “This might be the most opportune time, if the Fed does want to pause, to go ahead and suggest that.”
Fed fund futures have trimmed the odds of a December move from a near certainty to 32%. Increased expectations for stabilization in rates seem to be based on an improved growth outlook, as options traders favoring a rise in long-dated yields have helped to buoy the curve.
The gap between the two- and 10-year yields has widened from 4 basis points at the start of October to 17 basis points, as the longer-dated benchmark has climbed from a low of 1.5% to 1.80% as of Friday.
Nasty Undertow
Of course, this composure might not hold for long: An undercurrent of concern about the U.S. growth outlook remains. That view was clearly in play last week, with a large bet on the Fed policy rate heading to zero next year.
That was a day after Brian Sack, director of global economics at D.E. Shaw group, told an Institute of International Finance conference “we either stabilize with one more cut, or I think we’re going to go all the way to the lower bound.”
While Rajappa expects the Fed will cut rates next week and signal it’s done for now, she says the data to follow might well undermine its intentions. She’s anticipating a recession next year, and thinks the market’s current pricing is “a sweet spot for things to go the other way.”
Data Wednesday are expected to show the U.S. economy grew 1.6% annually last quarter, the slowest pace this year. Economists are looking for Friday’s payrolls data to show an 88,000 increase in jobs in October, well below the prior month’s 136,000 gain.
The U.S. labor market has been a robust foundation of this expansion as it enters its second decade, allowing consumer demand to thrive. Signs of that support crumbling could be the trigger for another searing Treasuries rally and for the Fed to take a hatchet to interest rates.
“I almost think we’re one bad employment figure away from them saying, these weren’t insurance cuts, these were real cuts, and we haven’t done enough,” said Mark Spindel, chief executive officer of Potomac River Capital in Washington, DC.
What to Watch Next Week
- It’s a high-octane week for central banks -- decisions are coming from the Federal Reserve and Bank of Canada Wednesday and the Bank of Japan Thursday
- Four Fed speakers will be on hand Friday to handle any blowback:
- Oct. 30: FOMC policy statement and Chairman Jerome Powell press conference
- Nov. 1: Vice Chairman Richard Clarida speaks in New York; Vice Chairman for Supervision Randal Quarles discusses the price system; New York Fed’s John Williams participates in Q&A at Rutgers, Dallas Fed President Robert Kaplan speaks in Houston
- Here are some of the key items on the economic calendar
- Oct. 28: Chicago Fed activity index; advance goods trade balance; wholesale/retail inventories; Dallas Fed manufacturing activity
- Oct. 29: Home price indexes; Conference Board consumer confidence; pending home sales
- Oct. 30: MBA mortgage applications; ADP employment change; GDP; personal consumption; GDP price index; core PCE
- Oct. 31: Challenger job cuts, employment cost index; personal income/spending; PCE deflator; initial jobless claims; MNI Chicago PMI; Bloomberg consumer comfort
- Nov. 1: Nonfarm payrolls; Markit manufacturing PMI; ISM manufacturing; construction spending; Wards total vehicle sales
- On the auction block
- Oct. 28: $45 billion 3-month bills, $42 billion 6-month bills
- Oct. 30: Treasury 4Q refunding announcement
- Oct. 31: 4- and 8-week bills
--With assistance from Edward Bolingbroke.
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, Debarati Roy, Mark Tannenbaum
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