Bond Traders Are No Fools, Dismissing Bluster of Four Rate Hikes

EghtesadOnline: To kick off the second quarter, bond traders will look to a fresh reading on the job market to gauge which Federal Reserve speaker has the best grip on the U.S. economy.

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02 April 2017

Ten-year yields ended last week near the lowest levels of March, after gaining Friday when New York Fed President William Dudley said three rate hikes in 2017 is a “reasonable” projection and the economy isn’t overheating. The Boston Fed’s Eric Rosengren voiced the risk of running too hot two days earlier. He said four rate increases in 2017 could be warranted, and the San Francisco Fed’s John Williams also didn’t rule out four, according to Bloomberg.

The bond market sided with Dudley, amid growing skepticism about the reflation trade. A market-based gauge of inflation expectations isn’t far above its 2017 low, and economic data surprises, which peaked just in time for the central bank’s March hike, are retreating from the highest levels since 2014, Citigroup Inc. data show.

“The Treasury market is taking a more cautious view and just saying, ‘Prove it to me,”’ said John Bredemus, an investment strategist for Allianz Investment Management, which oversees $700 billion. “There’s a lot of promise out there, and we’ve been disappointed often in the last few years around inflation moving up and justifying higher rates.”

Seeking Evidence

The proof may come this week when the Labor Department releases March payrolls data. The median forecast in a Bloomberg survey is for an addition of 175,000 jobs.

With recently monthly job gains exceeding 200,000, Treasuries face an “asymmetry of risks” going into the report, BMO Capital Markets strategists Ian Lyngen and Aaron Kohli wrote Friday in a note. A disappointing result will spur a larger drop in yields than an above-consensus number will increase them, they said.

The 10-year Treasury yields about 2.39 percent, after fluctuating in a range of 2.3 percent to 2.63 percent last quarter.

Traders will also get a better glimpse into the minds of Fed officials from the April 5 release of the minutes of the March meeting. The futures market is pricing in almost 1.7 additional Fed increases this year, so not quite three for all of 2017.

Inflation Debate

What the minutes show about inflation expectations may garner scrutiny, with measures of the yield curve indicating limited concern about a pickup in price pressures. The spread between five- and 30-year debt is close to the smallest since 2007.

A market-based gauge of the inflation outlook, the 10-year break-even rate, is about 1.98 percentage points, close to the year’s low. That’s even after the Fed’s preferred measure of price growth climbed to 2.1 percent in February, exceeding the central bank’s goal of 2 percent for the first time since 2012.

Rosengren, for his part, said he sees inflation worries in wages and asset prices. He argued that four hikes was gradual relative to the last tightening cycle. Williams said the central bank’s role is to keep the economy from overheating.

“This is such a change of the longer-term pattern of the Fed having been so dovish,” said Irvine, California-based Putri Pascualy, portfolio manager at Pacific Alternative Asset Management Co., which manages $10 billion. “We are in that inflection point where we are going the other way, so they feel that they really need to prepare markets for it.”

What to watch next week:

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April 3

Markit Manufacturing PMI
ISM Data

Fed’s Dudley in New York

Fed’s Harker in Philadelphia

April 4

Trade Balance
Factory Orders

Durable Goods Orders

Fed’s Tarullo at Princeton U.

April 5

MBA Mortgage Applications
ADP Employment

Markit Services PMI

ISM Non-Manf. Comp.

FOMC Meeting Minutes

April 6

Initial Jobless Claims
Bloomberg Consumer Comfort

Fed’s Williams in Frankfurt

April 7

Payrolls Data
Fed’s Dudley in New York