Bond Traders Face Deja Vu of Risks From Shutdown to Inflation

(Bloomberg) -- Treasuries traders may get a feeling of deja vu next week -- they’ll be contending with some familiar geopolitical risks as they also absorb key economic data that could help solidify expectations for Federal Reserve policy.

Brexit negotiations, trade talks and the specter of another U.S. government shutdown loom against the backdrop of growing concern over the global economy. Market rates are also back in a familiar place: Benchmark 10-year yields are approaching the 11-month lows set in early January, before the Fed signaled it would be patient in tightening policy further.

Given that Chairman Jerome Powell said last month that inflation was a “big part” of what he needs to see to warrant further rate increases, that puts added focus on Wednesday’s update on consumer prices. The consensus forecast is for the weakest annual reading since 2016. Either way, the data may usher in a turbulent stretch, with traders now leaning toward a rate cut as the Fed’s next move.

“Some amount of good news on the economic front would cause the back end of the curve to sell-off,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA. But with weakness, “people will price in an even more dovish Fed policy stance and that will also steepen the yield curve.”

After a three-week rally in Treasuries, 10-year debt yields about 2.63 percent. The yield touched as low as 2.54 percent on Jan. 4 in the wake of a swoon in stocks amid concern the Fed would keep hiking rates despite global growth headwinds. Market measures of inflation expectations have also sunk. The breakeven rate on five-year inflation-linked Treasuries is about 1.7 percent, down from as high as 2.08 percent last quarter.

“We don’t see a lot of evidence that would suggest inflationary pressures in the U.S. are building to the point where the Fed really needs to pick up the pace of hikes,” said Tiffany Wilding, U.S. economist at Pacific Investment Management Co. “We expect the Fed to have a prolonged period of keeping rates on hold, with it possible that they could opportunistically hike one more time over the next year or so.”

The risk of rising protectionism, especially between the U.S. and China, is high on investors’ list of concerns, especially given world output is already slowing. Should the two sides fail to hammer out an accord by the March 1 deadline set by President Donald Trump, it could intensify the global trade war.

This week, the European Commission slashed forecasts for the euro region, the Bank of England said the U.K. may grow at its slowest pace in a decade and the Reserve Bank of Australia also lowered its growth and inflation projections.

“What’s the biggest cause of this uncertainty? It’s that these trade talks haven’t been going so well and companies are starting to worry more,” said Dan Fuss, vice chairman of Loomis Sayles & Co., which manages about $250 billion. “The geopolitics are a factor in the economics. I don’t think you can understate that at all.”

What to Watch

• On top of a fresh round of trade talks in Beijing, the market will also get comments from Powell, among a slew of policy makers on the calendar:
  • Feb. 11: Fed Governor Michelle Bowman in San Diego
  • Feb. 12: Powell speaks in Mississippi about rural poverty; Cleveland Fed’s Loretta Mester in Ohio; Kansas City Fed’s Esther George
  • Feb. 13: Mester speaks in Kentucky; Atlanta Fed’s Raphael Bostic in Dublin; Philadelphia Fed’s Patrick Harker on the economic outlook
  • Feb. 14: Harker speaks on leadership
  • Feb. 15: Bostic in Alabama
• For economic data, retail sales and consumer prices will be key:
  • Feb. 12: NFIB small-business optimism; Jolts job openings
  • Feb. 13: MBA mortgage applications; consumer prices; monthly budget statement
  • Feb. 14: Retail sales; producer prices; jobless claims; Bloomberg consumer comfort; business inventories
  • Feb. 15: Empire manufacturing; import/export prices; industrial production; University of Michigan sentiment; Treasury International Capital flows for December
• Here’s the schedule for Treasury auctions, which include only bill sales
  • Feb. 11: $45 billion of three-month bills; $39 billion of six-month bills
  • Feb. 14: Four- and eight-week bills

To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net

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

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