Inflation Markets Send Worrying Signal on the Fed’s Stance
(Bloomberg) -- One of the Federal Reserve’s goals for its first rate cut in a decade was to lift the market’s sights on inflation. The initial reactions look not just disappointing for policy makers but near-disastrous.
Market measures of inflation moved higher only briefly following the quarter-point reduction Wednesday, and have been sliding since. The accompanying decline in long-dated Treasury yields reflects investors’ suspicions that the Fed’s action -- which Chairman Jerome Powell said wasn’t the start of a prolonged period of easing -- won’t be enough to protect U.S. growth.
“I think that the Fed has to be pretty worried about the response,” said Eric Patlovich, a fixed-income portfolio manager at New Century Advisors. “It screams policy error where you see the flattening of the curve, you see inflation expectations continuing to come down. That’s just markets telling the Fed they’re going to force its hand into cutting more.”
The pressure on the Fed only intensified Thursday afternoon, when President Donald Trump escalated his trade war with China by tweeting out a plan to add new tariffs on $300 billion of imports. In the aftermath, inflation expectations took another leg down and the two-year Treasury caught a wave of buying as investors piled back into positioning for lower interest rates.
The 10-year breakeven rate, a gauge of where the market thinks consumer price inflation is headed over the coming decade, has fallen 7.7 basis points from its level just before the Fed’s decision, reaching 1.70%. The Fed has a 2% inflation target. The move reverses much of the modest upward trend in the weeks before the Fed’s July 30-31 meeting, when traders entertained the prospect of a larger, half-point cut.
The tariff tweet Thursday afternoon whipsawed the Treasury market, as investors positioned for another Fed easing. The two-year yield’s post-Fed rise swiftly reversed, taking the level to its lowest point since November 2017. The 10-year yield pushed down to 1.89%, reflecting market concerns that the Fed’s actions might not be enough to avert a trade-related hit to global growth.
“When tariff tweets go out, inflationary expectations dive,” said John Velis, an FX and macro strategist at Bank of New York Mellon. “This underscores the effect that trade uncertainty has on the demand outlook.”
New Century’s Patlovich says he expects that policy makers will have to take further action before long, whether it’s a cut in September or December. In his view, ultimately, “the Fed decides when to hike and the market decides when to cut.”
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