Bond traders are wagering that the longer-term trajectory for interest rates will be lower even if the Federal Reserve is still actively boosting its policy rate in anticipation of a US recession in 2019. The Fed’s current overnight benchmark range for long-term Treasury rates is currently 3.75% to 4%, and there is still one more percentage point of central bank rate hikes priced in for the upcoming months. The options market has also shown activity, which may indicate that some investors are hedging against the possibility that policy rates could eventually decrease by half from their current level.
Investors have been buying bonds instead of waiting for clear economic proof that this year’s frantic monetary tightening will result in recessionary conditions in 2023; this position has been supported, among others, by Pacific Investment Management Co.
Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities, stated that the Federal Reserve’s policy is dynamic and that it continues to indicate that rates will rise. But the market behaves as though the Fed’s endgame is one that it is more at ease with.
This week, demand for longer-term Treasuries pushed the rates on 10- and 30-year notes to the lower limit of the Fed’s overnight range. The most dramatic yield curve inversion in four decades has intensified as a result of front-end rates remaining largely stable; this is a closely studied sign of probable future economic suffering.
Although the Fed views the recession indicator as a component of the problem, Faranello said, “the recession indicator story is robust.”
The US economy, and the labor market in particular, has demonstrated itself to be rather resilient thus far in the face of Fed rate rises intended to try to limit rising and presumably persistent inflation. Investors will therefore be closely watching the monthly jobs report this upcoming Friday for any hints of a slowdown or whether it may open the door for the Fed to alter its current course of action.
They will be closely examining the statements made by Fed Chair Jerome Powell and his colleagues, who will appear in public for the final time next week before entering the normal blackout period prior to the Fed’s policy meeting on December 13–14. Officials have been adamant in repeating the necessity for policy rates to rise above present levels, even if minutes of their most recent meeting indicated that they’re likely to decrease the pace of tightening soon.
Given that expectations of a gradual slowing of policy tightening from here amid a perception that inflation has peaked and job growth is slowing, Fed jawboning may prove less effective than the tone of data at this stage of the cycle.
As traders negotiate a number of important data in the upcoming week, not just the employment report, there may be some turbulence for Treasuries due to the extent of current bullishness in the long end of the bond market and the depth of the yield curve inversion. The ISM manufacturing index is expected to decline, which may help wagers on a recession, and the personal income and spending data will reveal how things are changing for personal consumer expenditure, the Fed’s favored inflation indicator. Additionally scheduled for distribution are statistics on the number of open positions.
According to swap-market projections, the effective fed funds rate will increase to almost 5% by the middle of next year before declining by more than 0.5 percentage points by the beginning of 2024. The week’s trading in Secured Overnight Financing Rate futures, however, have been centered on the possibility of a decrease to 3% or even 2% by the end of 2023 or early 2024. However, some are banking on a considerably sharper reverse.
Despite this, not everyone agrees with the consensus on the bond market on the Fed, the economy, and, of course, the inevitable return of low inflation in 2019. The 10-year will continue to trade around 4% through 2024, according to Goldman Sachs Group Inc., which stated this week that hopes for rate cuts next year have been crushed by the economy’s failure to enter a recession and the high level of inflation.
However, that is not the primary viewpoint. Market pricing indicates that many investors are increasingly shifting their attention away from the prospect of constant Fed rises and toward a potential economic slowdown, even if the Fed itself has not yet changed its policy.
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