In one fell swoop, the bond market’s pent-up expectations for a rate cut have started to unravel.
Federal Reserve Chairman Jerome Powell said Wednesday that he didn’t expect the subdued inflation numbers of 2019 to last for long, and that inflation would eventually rebound to the central bank’s target of 2%. Much as at previous Fed meetings, this was remark by Powell that caught the bond market off-side as investors rushed to pare their bullish positions on short-dated Treasurys, designed to profit from a potential easing of monetary policy.
See: After a sterling first-quarter GDP number, rate-cut bets gain steam. What gives?
“Jay Powell conceded no ground to the doves at yesterday’s press conference,” wrote Thierry Wizman, global interest rates and currencies strategist at the Macquarie Group.
Since then, the 2-year Treasury note yield TMUBMUSD02Y, +0.00% , arguably the most sensitive to the Fed’s shifting expectations, has climbed to 2.345%, around 11 basis points above Wednesday’s intraday lows when the Fed released its policy statement. Bond prices move inversely to yields.
The rise in short-dated yields helped flatten the so-called yield curve, or the spread between short-dated and long-dated yields. The 2-year vs.10-year spread narrowed to 19 basis points, from 24 basis points at the start of the week, Tradeweb data shows.
Trading in fed fund futures indicates the outlook for a rate cut by the January 2020 meeting fell to 57.9% from 66.5% a day before, CME Group data show.
Powell’s remarks also weighed on the bullish sentiment in equities, pushing stock-market benchmarks down for the second session in a row. The S&P 500 SPX, -0.21% and the Dow Jones Industrial Average DJIA, -0.46% finished lower Thursday.
Heading into the Fed’s two-day meeting, most bond investors were growing increasingly confident that the central bank would eventually cut rates by 2020, as either subdued inflation and slower global growth forced the Fed’s hand. Money managers had increased their long positions in the 2-year note future for seven straight weeks, according to Societe Generale. If the Fed cut rates, the short-dated yields would fall and the yield curve would steepen.
When the Fed released its policy statement on Wednesday stating that inflation was running below 2% instead of repeating previous language that prices were running near the central bank’s target, bond investors saw the tweak as another sign that their rate-cut convictions would bear fruit.
Yet only half an hour later, traders suffered whiplash when Powell took the stage at the postmeeting news conference. The Fed chairman took aim at market participants who believed the slide in inflation this year would prompt a rate cut. Not only did Powell suggest transitory factors were responsible for the recent slide in inflation; he also refused to specify what level inflation had to reach before the Fed’s rate-setting committee contemplated a rate cut.
Opinion: Just when you got used to core inflation, Powell talks up another measure — ‘trimmed mean’
Core personal consumption expenditures, the Fed’s preferred price measure, had steadily slipped to 1.55% in March from 1.95% in December.
“I don’t think we can go through a Powell conference without a communication surprise,” said Craig Bishop, vice president of U.S. fixed income at RBC Wealth Management, in an interview with MarketWatch.
Still, plenty of bond investors still foresee a rate cut sooner or later.
Some anticipate Powell to come around to the bond-market view that persistently low inflation may last for longer than the central bank anticipates. After all, a multidecade low in unemployment rates has yet to show signs of stimulating rapid wage increases, and thus the inflation needed to justify Powell’s view that subdued inflation will prove temporary.
In a rebuke of Powell’s assessment of the inflation outlook, the 10-year break-even yield, or what bond investors anticipate prices to average over the next decade, retreated to 1.89% from a recent high of 1.98% last Thursday.
“I don’t think you can necessarily say a rate cut is off the table completely,” said Bishop.
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