Bond Market Eyeing Record-Low Yields Set for Nudge From the Fed

(Bloomberg) -- Treasuries traders are once again eyeing record low yields, with dimming hopes for a sharp U.S. growth recovery fueling expectations that the Federal Reserve is about to signal more accommodation ahead.

The benchmark 10-year yield just posted its lowest-ever weekly close, at 0.59%. And after stripping out inflation, the real yield -- one of the market’s purest reads on the economy -- has almost never finished a trading day lower than Friday’s minus 0.91%.

Wall Street strategists expect Fed Chairman Jerome Powell to send a sufficiently dovish message after the central bank’s July 28-29 meeting to sustain downward pressure on yields, which have also been sinking amid mounting coronavirus cases and escalating U.S.-China tension. The odds are that no concrete changes emerge, but traders are betting that officials will hint at further steps, such as changes to guidance on its policy rate.

“The message from the Fed will be strong -- that they are all in -- with it clear that they are getting more concerned about Covid’s effects and economic growth in the second half,” said Gregory Faranello, head of U.S. rates at AmeriVet Securities in New York. “Long-end Treasury rates are hugging the bottom of their range and seem to want to go lower. That reflects also that there’s a ton of uncertainty about the virus and geopolitics.”

Data Push

Economic data could also keep bond bulls in the driver’s seat during the final days of July.

The week brings the first look at second-quarter growth, which is expected to show the economy collapsed at a staggering 35% annual rate. Fresher readings on the job market this past week suggested the rebound was stalling just as a key part of the government’s pandemic relief is about to expire, with lawmakers in Washington struggling to agree on new stimulus measures.

Just on Friday, JPMorgan Chase & Co. strategists lowered their year-end forecasts for the 10-year yield to 0.8% from 1%, and for the 30-year to 1.65% from 1.85%, citing the economic outlook and the likely Fed policy response.

The 10-year benchmark is starting to slip back toward its record intraday low of 0.31% set in March. One step the market is preparing for in the coming months is for the Fed to tilt its Treasuries purchases more toward longer-term debt to lower borrowing costs. It would be part of a transition to stimulating the economy through its buying, rather than smoothing the market’s functioning.

“The Fed has indicated that they’re going to shift their large-scale asset purchase programs from focusing on market function -- which is now good -- to focusing on how do you actually stimulate the economy,” Bill Dudley, former president of the New York Fed, said in a Bloomberg Television interview on July 23. “That does imply they’re going to buy a greater proportion of longer-dated Treasuries.”

Inaction Risk

Still, some analysts see room for disappointment out of the Fed that could push yields higher, given that there’s likely a segment of the market that’s bracing for action this coming week to counter the darkening outlook.

“A lack of any new signals of additional monetary support would be a surprise on the ‘hawkish’ side,” Wells Fargo analysts including Zachary Griffiths wrote in a note.

Last month, the Fed held rates near zero and indicated it would probably keep them there through 2022. Several officials have since said the central bank should consider keeping them there until inflation is above its 2% target. Economists surveyed by Bloomberg project the Fed by September will begin linking its guidance on the policy rate to inflation.

Read more on Bloomberg’s survey of economists.

The backdrop has Morgan Stanley strategists predicting that 5-year real yields will fall further and advising investors to stay long 5-year Treasury Inflation-Protected Securities and 30-year breakeven rates.

What to Watch

• The economic calendar:
  • July 27: Durable/capital goods orders; Dallas Fed manufacturing activity
  • July 28: S&P CoreLogic home price data; Conference Board consumer confidence; Richmond Fed manufacturing index
  • July 29: MBA mortgage applications; advance goods trade balance; wholesale/retail inventories; pending home sales
  • July 30: Gross domestic product; jobless claims; Bloomberg consumer comfort
  • July 31: Personal income/spending; PCE deflator; employment cost index; MNI Chicago PMI; University of Michigan sentiment
• The Fed calendar
  • Chairman Powell will hold a press conference on July 29 after the Fed’s two-day meeting
• The auction calendar:
  • July 27: 13-, 26-week bills; 2-, 5-year notes
  • July 28: 42-, 120-day cash management bills; 2-year floating-rate notes; 7-year notes
  • July 30: 4-, 8-week bills

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