Treasury Market Rally Faces Reality Check As Powell Hits The Path

(Bloomberg) — The optimism that has crept into the US bond market is about to be tested.

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The Treasury market rebounded this week, posting a 12-week loss streak, on speculation that the Federal Reserve will signal plans to scale back its rate hikes after a fourth consecutive three-quarter rise on Nov. 2.

The advance pushed the 10-year benchmark yield back about 4%, with some investors guessing the bond market defeat would end for good as the central bank’s earlier moves show signs of slowing the economy. The position has received support from Fed officials who have indicated that the pace of monetary policy tightening could slow towards the end of the year, potentially aligning itself with policymakers at the Bank of Canada and the European Central Bank. who are adjusting course or highlight the opportunity to do so.

But investors remain deeply divided over what the Fed will do in December, with futures traders still factoring in the probability of a 0.75 percentage point rate hike. And it remains possible that neither Fed Chair Jerome Powell nor the October jobs report will clarify the outlook, which will likely depend on whether inflation shows signs of a steady decline from its four-decade high.

“What will be interesting is whether Powell is trying to say the frontloading is over as they reach their final estimate,” said Priya Misra, global head of rate strategy at TD Securities, referring to where the Fed’s key rate will peak. “Powell has to say that terminal risks are on the upside, but any message from the Fed downsizing will be taken as lenient by the market.”

Story continues

The recent recovery in the bond market marks the latest turn in a turbulent year, one with the biggest losses in at least half a century and the most lingering volatility since the onset of the financial crisis in 2007. Traders were burned by optimism about a false bottom earlier this year on speculation that growth has cooled, and recent options trading shows the lack of conviction, with some aiming for yields to fall to 3.6% and others to rise to 4.25% by the end of November.

Over the next two weeks, jobs and inflation data, as well as Powell’s comments after Wednesday’s meeting, will provide more insight into whether the current market outlook is correct.

Major data releases are expected to see the ISM manufacturing index decline to 50, the dividing line between expansion and contraction, in October, while the services meter only moderates to 55.5. The week is topped off with the monthly jobs report projected to show 200,000 new jobs in October, a slight decline over the month, as the pace of annual wage growth falls to 4.7% from 5%.

Inflation peak?

This week’s US inflation data suggested it could peak, with the personal consumption expenditure index remaining stable in September at an annual pace of 6.2%. But caution is advised as 10-year government bond yields rose Friday and European bonds sold off sharply in the wake of double-digit inflation readings from Italy and Germany.

“The Fed is definitely going to go to 75 in November, and I think they’re going to hold back in December as there are two more CPI reports before that meeting,” said Donald Ellenberger, senior portfolio manager at Federated Hermes. “They want to get off the 75 basis point treadmill, but the Fed can only step back if inflation rates start to fall.”

Expectations that the Fed will signal plans for an eventual slowdown have been bolstered by growing concerns that already tight financial conditions will trigger a recession. That was highlighted this week when the 10-year yield fell below the 3-month rate the most since March 2020.

That move was driven by investors who increased their holdings of longer-term debt in the expectation that growth would slow so much that the Fed will cut interest rates next year. SMRA’s most recent portfolio survey found that investors returned to net long territory at 100.1% for the first time since 2021, while a survey by JPMorgan Chase & Co. among Treasury clients returned to a net long position at its two-year high.

“The bond market is telling you the Fed is nearing its endgame and duration is getting a bid as data points to a slowing economy next year,” said Arvind Narayanan, senior portfolio manager at Vanguard Group Inc. “The balance is between how much inflation falls versus lower growth. If inflation is sticky versus growth, the economy will tip into recession and that will see Treasuries rise and long maturity will work for investors.”

what to watch

Economic calendar

October 31: MNI Chicago PMI; Production Activity of the Dallas Fed

01 Nov: Jolts vacancies; ISM production; S&P Global Manufacturing PMI in the US; construction expenses; Sale of vehicles of the department

Nov 02: MBA Mortgage Applications; ADP Employment, FOMC Rate Decision

03 Nov: Trade balance; jobless claims; unit labor costs; factory orders; Durable Goods Orders, ISM Service Index

November 4: US Employment Report

Fed Calendar:

Auction calendar:

October 31: 13, 26 week bills

01 Nov: 52 weeks of bills

02 November: 17 week bills

Nov 03: 4-, 8-week bills

–With the help of Ye Xie and Edward Bolingbroke.

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