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Bond Traders See Little on Radar to Derail Fed Rate-Cut Bets

Bond Traders See Little on Radar to Derail Fed Rate-Cut Bets

(Bloomberg) -- There’s little ahead to quash the bond market’s confidence that the Federal Reserve will cut rates as soon as July, as the backdrop of weakening growth and tepid inflation may outweigh any potential easing of trade tensions in the coming days.

The focus now for traders -- who see a quarter-point rate cut by the end of July as a lock -- comes Monday or even earlier, ahead of a U.S. deadline for tariffs on Mexican goods. U.S. President Donald Trump said Friday there’s “a good chance” of a deal with Mexico, but improvement on that front may not move the needle much as negotiations with China are still looming.

Data next week could also confirm that inflation remains tame, and with Fed officials entering a blackout period before their June 18-19 policy meeting, they’ll have no opportunity to push back against the market’s prevailing narrative. Traders’ conviction that easing is inevitable only grew after Friday’s jobs report for May showed that U.S. employers added the fewest workers in three months as wage gains cooled.

Bond Traders See Little on Radar to Derail Fed Rate-Cut Bets

“The deadline for Mexico’s tariffs is top on our mind now, yet even if they are delayed the market will likely still price in about a 50-50 chance for a Fed rate cut in July,” said John Briggs, head of strategy for the Americas at NatWest Markets. “That’s because the inflation backdrop remains benign. And the hurdle for getting the Fed to reduce rates may be lower now given growth concerns are increasing.”

Upside Down

Ten-year yields touched 2.05% Friday, the lowest since September 2017. They’re about 20 basis points below three-month rates, a worrisome sign for some investors because this kind of inversion has heralded recessions in the past. Traders expect about 70 basis points of easing by the end of 2019, which would mean potentially unwinding three of last year’s four rate hikes.

NatWest’s Briggs sees the 10-year yield ending the year at 1.85%. The bank’s economists forecast that the Fed will lower rates by a quarter-point in both September and October.

Most Fed watchers’ base case is that the central bank stands pat in June before more likely cutting in July. Chairman Jerome Powell opened the door to a possible rate cut this week when he said the Fed “will act as appropriate to sustain the expansion.’’

A June 12 update on consumer prices is expected to show that inflation remains subdued. The consensus forecast is for an annual increase of 1.9% in May, down from 2% in April.

While Friday’s data were downbeat, it wasn’t all doom and gloom this week: A measure of service industries beat almost all estimates.

The market’s confidence in rate cuts does raise the risk of volatility if traders have to re-evaluate their outlook, said Nancy Davis, founder of Quadratic Capital Management LLC, which specializes in options-based macro strategies.

Bank of America Corp.’s MOVE Index, a measure of anticipated price swings in Treasuries, surged this week to its highest since January 2017.

“The rates market is forcing the Fed’s hand,” Davis said. “But I don’t think the Fed at its next meeting is going to be as dovish as people are expecting, as overall the data isn’t that bad.”

What to Watch in the Coming Week:

  • Finance and central-banking chiefs from the Group of 20 gather this weekend in Fukuoka, Japan, and the trade war is topic number one.
  • Here’s the U.S. economic calendar:
    • June 10: JOLTS job openings
    • June 11: NFIB small business; producer price index
    • June 12: MBA mortgage applications; consumer price index; monthly budget statement
    • June 13: Import/export prices; jobless claims; Bloomberg June U.S. economic survey; Bloomberg consumer comfort
    • June 14: Retail sales; industrial production; University of Michigan sentiment
  • Here’s the schedule of Treasury auctions:
    • June 10: $36 billion of 3-month bills; $36 billion of 6-month bills
    • June 11: $38 billion of 3-year notes
    • June 12: $24 billion of 10-year notes
    • June 13: $16 billion of 30-year bonds; 4- and 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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