The Federal Reserve is walking a tightrope as the bond market cranks up the pressure on monetary-policy makers to ease benchmark borrowing costs.
Tuesday’s stock market rally (and gains for global debt prices) demonstrated the heightened expectations for more dovish policy from the Fed, underlining its difficult position as analysts say the central bank is unlikely to cut rates immediately with economic data yet to point to an imminent downturn. The more likely scenario would be for the rate-setting Federal Open Market Committee to make use of the two-day meeting that started Tuesday to open the door to an interest-rate cut later this year, they said.
“This morning’s move is about falling global yields and not the US data. This clearly complicates the FOMC’s decision as investors await the most exciting Fed meeting in recent memory,” wrote Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, obliquely referring to weakening data, including a disappointing reading of job creation and the worst decline in the Empire State manufacturing index on record.
The 10-year Treasury note yield TMUBMUSD10Y, +1.25% briefly touched an intraday low of 2.017% on Tuesday, its lowest since Sept. 2017. The benchmark rate stands at the precipice of breaking below 2%, a key psychological level that traders say, if broken, could presage further yield declines. Falling below 2% would result in the 10-year yield matching its lowest levels since Nov. 2016, when Trump’s inauguration stirred a bond-market selloff amid expectations for tax cuts and looser fiscal policy.
Prices for U.S. and European government paper surged after European Central Bank President Mario Draghi on Tuesday said that policy tools remained to boost inflation and growth.
The yield on 10-year German government debt TMBMKDE-10Y, +9.70% slid 8 basis points to negative 32 basis points on Tuesday. Debt prices move in the opposite direction of yields.
See: ‘Currency war’ fears rise as Trump slams Draghi’s hint at more ECB stimulus
Though, some analysts say global economic headwinds emanating from U.S.-China trade tensions could lead the central bank to carry out pre-emptive “insurance” cuts to prop up domestic growth, others remain skeptical the Fed will act swiftly when data has only started to weaken.
“They’re in a tough spot because if you look at the U.S. fundamentals, it has been softening up but it doesn’t necessarily point to an impending recession. In prior Fed regimes, it isn’t clear this data would give the Fed the justification to be as dovish as the market wants them to be,” said Pramod Atluri, a fixed-income portfolio manager at Capital Group, told MarketWatch.
Paul Christopher, head of global markets strategy for Wells Fargo Investment Institute, said in an interview that the economic data weren’t deteriorating fast enough to merit a rate cut in June or July. He added the Fed was more likely to act in September or later this year.
But traders on the fed-fund futures market expect at least two rate cuts this year, leaving plenty of room for disappointment.
Still, some strategists say even if the central bank fails to deliver on investors’ calls for sufficiently dovish language from the Fed, bond-market bulls have little to fear because debt price gains are unlikely to be unraveled. Bond prices and yields move in opposite directions.
Christopher said yields wouldn’t likely reverse their multimonth decline with inflation pressures remaining muted. The 5-year, 5-year forward break-even rate, which tracks the average expected inflation rate over the coming five-year period beginning five years from now, stood at 1.78% as of last Friday, its lowest levels since June 2017.
In addition, bond investors continue to contend with geopolitical uncertainty and slower global growth, forces that have kept yields anchored lower.
“If the Fed isn’t as dovish as the market would like, it isn’t obvious if interest rates can rise substantially,” said Atluri.