Judgment day for the US bond market has been postponed for at least a week.
While Federal Reserve Chairman Jerome Powell’s speech at the central bank’s annual meeting in Jackson Hole on Friday was unequivocally hawkish, the market remains nearly evenly divided on the outcome of next month’s policy meeting. Continued high inflation makes a rate hike inevitable, but the magnitude “will depend on the totality of incoming data and how the outlook changes,” Powell said.
Some parts of the total are more important than others, and next week’s jobs report – as well as the September 13 consumer price index – are among the most important. Either or both could seal the case for another three-quarter point hike or a smaller half-point move. In the meantime, traders are retreating to longer-term bets on the flattening of the yield curve and lower rate volatility.
“A hugely large jobs report will validate the case for 50 or 75 basis points,” said Alan Ruskin, chief international strategist at Deutsche Bank AG. “If we see strength in jobs, that means the Fed can go to 75 and raise rates quickly without risking growth.”
Besides the August jobs report next week, US economic data likely to alter expectations include the ISM manufacturing and the Conference Board’s consumer confidence gauge.
The hawkish highlights of Powell’s speech on Friday — he said a restrictive policy was likely to remain in place “for some time” and that history “strongly warns against premature easing of policy” — has helped push the yield on the two-year Treasury bill up to 3.44%, one basis point near its high for the year. Earlier in the day, however, weaker-than-expected income and spending data for July boosted gains that sent the two-year yield down to 3.34%.
Nonetheless, the market response pushed short-term yields higher relative to longer-term ones. The yield on the two-year note exceeded that of the 10-year note by nearly 40 basis points at one point, and the yield on the five-year note exceeded that of the 30-year bond for the second time this this month. Traders established short positions on rate volatility, anticipating a continued stalemate.
“People have confidence in the Fed, and that anchors long-term rates with limited short-term decline,” said Christian Hoffman, portfolio manager at Thornburg Investment Management. “Uncertainty is more up front, and people are concerned that the Fed is going too strong, which helps in the long run.”
Confusing matters somewhat, next week’s month-end Bloomberg Treasury Index rebalancing creates a larger-than-average need for bond managers to buy long-dated Treasuries until the end of the month. September 1st.
The more lasting change in rate expectations after Powell’s speech further reduced bets that the Fed’s key rate, after peaking in March at around 3.80%, will come down by the end of the year. The December 2023 swap contract rate referencing the effective central bank rate ended about five basis points higher at 3.43%. It was below 3% as recently as August 4, the day before the stronger-than-expected July jobs report.
Expectations of tighter financial conditions also drove up short-term, or inflation-adjusted, real yields. The two-year rose to 0.61% on Friday, the highest level since the market turmoil of early 2020 and up from minus 0.25% earlier this month.
“There was a huge pullback from the Fed on market prices in a political pivot, and Powell sealed that position,” said George Goncalves, head of US macro strategy at MUFG. “Rates have been adjusting much higher in recent weeks, but they can still climb from here on strong data. Treasury along the way.
What to watch
- Economic calendar:
- August 29: Dallas Fed manufacturing activity
- August 30: Conference Board Consumer Confidence; JOLTS job postings; FHFA house price index; S&P CoreLogic CS House Prices
- August 31: MBA mortgage applications; ADP Employment; IMN Chicago PMI
- September 1: ISM Manufacturing; applications for unemployment benefits; construction expenses
- Sept. 2: Employment Report; factory orders
- Fed Calendar
- August 29: Governor Lael Brainard
- August 30: Thomas Barkin, president of the Richmond Fed; John Williams, President of the New York Fed
- August 31: Loretta Mester, President of the Cleveland Fed; Atlanta Fed Chairman Raphael Bostic
- September 1: Bostic
- Auction schedule:
- August 29: 13 and 26 week invoices
- September 1: 4 and 8 week invoices
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