Bond Traders Face Plenty of Risk as Powell Ushers In a New Era

(Bloomberg) -- Treasury traders are bracing for heightened volatility next week as Federal Reserve Chairman Jerome Powell ushers in a new era of press conferences after every meeting, while the U.S. and China meet again for trade talks.

Officials are expected to keep interest rates unchanged following nine hikes since 2015. But investors see scope for the Fed’s statement to tilt dovish, or for Powell to signal as much in his comments, a shift that could help drive yields lower. Also in focus -- any hint that the central bank is closer to ending its balance-sheet runoff, which, combined with the deal to reopen the government, could bolster risk sentiment at the expense of Treasuries.

But there’s more on the calendar: Progress on the trade front may lift yields as it’s seen as easing global economic headwinds. And the Treasury is slated to detail issuance plans for the coming three months, with sales projected to be at a record level. January labor data will round out the week, with the effects of furloughed government workers potentially boosting the jobless rate. Add it all up, and traders may have some countervailing forces to contend with.

“It’s going to be a busy week,” said Chris Ahrens, chief market strategist at First Empire Securities. “People want to know what Powell has to say about the balance sheet, with many wondering if they’ll adjust what they are doing now.”

At 2.76 percent, the benchmark 10-year Treasury yield has been stuck in a 14 basis point range the past two weeks. It’s rebounded from this month’s low of 2.54 percent amid improved investor confidence after Fed officials indicated they’d be patient in adjusting rates further. Bond-market volatility as gauged by options has dropped from a 10-month high reached in December.

Powell’s Turn

Powell will take center stage as his counterparts at other major central banks appear to be stalling in efforts to normalize monetary policy. This week, European Central Bank President Mario Draghi said risks to growth “have moved to the downside,” while the Bank of Japan cut its inflation outlook.

Ian Lyngen and fellow BMO Capital Markets strategists said in a note Friday that they expect “a bullish bias” in the five-year maturity area. That includes “a potential rally going into the FOMC meeting as expectations build for the Committee to pivot to a more dovish communication in the statement and Chairman Powell’s press conference.”

But at least one trader of Treasury options this week was using options to bet that a slate of Treasury auctions in the next two weeks will impede market gains.

Before the Fed’s decision Wednesday, traders will also get details on the supply they’ll have to absorb in the months ahead. That morning, the Treasury is expected to say at its quarterly refunding announcement that it will maintain elevated sales.

Tony Roth, chief investment officer at Wilmington Trust Investment Advisors Inc., says another year of $1 trillion of new issuance will weigh on Treasuries. That’s part of the reason they’re underweight duration.

“The bond market is mispricing risk on the long end of the curve, which should be steeper,” he said.

What to Watch

• No Fed speakers are on the docket until after their decision Wednesday
  • Jan. 30: FOMC decision, Powell press conference
  • Feb. 1: Dallas Fed’s Robert Kaplan speaks in Texas
• As for economic reports, it’s unclear when data postponed by the shutdown will be released. The following are among figures are expected:
  • Jan. 28: Chicago Fed activity index; Dallas Fed manufacturing index; Congressional Budget Office releases economic and fiscal forecasts; Treasury announces quarterly borrowing needs
  • Jan. 29: S&P CoreLogic home prices; Conference Board consumer confidence
  • Jan. 30: Weekly mortgage applications; ADP employment; pending home sales
  • Jan. 31: Challenger jobs; jobless claims; Chicago purchasing managers; Bloomberg consumer comfort
  • Feb. 1: Monthly employment data; Markit manufacturing; ISM manufacturing; University of Michigan consumer confidence
• Here’s the schedule for Treasury auctions:
  • Jan. 28: $42 billion of 3-month bills; $39 billion of 6-month bills; $40 billion 2-year notes and $41 billion of 5-year notes
  • Jan. 29: $26 billion of 52-week bills; $32 billion of 7-year notes and $20 billion of 2-year floating rate notes
  • Jan. 31: 4-, 8-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

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