Bond market sees no end to tumult as Fed casts a hawkish shadow

Investors anticipate that US Treasuries will continue to be whipsawed by heightened volatility as economic uncertainty threatens to alter the central bank’s path or keep rates pinned higher for far longer than traders currently expect. 

Already, some Fed officials are underscoring that there may still be more work to do as inflation continues to hold above their 2% target despite the most aggressive monetary policy tightening in four decades. At Barclays, strategists have advised clients to sell two-year Treasuries on anticipation that rates will remain elevated next year, bucking broader speculation that the Fed will initiate a series of rate cuts as soon as March. And benchmark 10-year yields — a baseline for the broader financial system —  are pushing back toward last year’s highs. 

“The rise in long-dated yields has been driven by the hawkish message from the Fed,” said Rob Waldner, chief strategist fixed income at Invesco. “The central bank is staying hawkish and that’s keeping uncertainty high.” 

That uncertainty, along with an increase in new debt sales as the federal government contends with mounting deficits, has weighed on the bond market. Even with the sharp jump in interest rates, the overall Treasury market returned just 0.1% this year, according to Bloomberg’s index, far short of the big gains once expected to emerge when the end of the Fed’s hiking appeared in sight. 

After the central bank’s policy meeting in July, when it raised its overnight rate by a quarter percentage point, Chair Jerome Powell emphasized that its decision at the next meeting in September would hinge on the data released over the next two months. 

So far, the major reports have generally supported speculation that it will hold steady in September, with job growth cooling and signs of easing inflation. But the core consumer price index — which strips out volatile food and energy prices and is seen as a better measure of underlying inflation pressures — still rose at a 4.7% annual pace in July. On Friday, an index of producer prices also rose at a faster-than-expected pace, driving up Treasury yields across maturities. 

In the coming week, traders will scour the release of the minutes from the July 25-26 FOMC meeting for clues on where policymakers see rates heading and any diverging views between them. 

The annual gathering of global central bankers in later this month in Jackson Hole, Wyoming, will also be closely watched. It could give Powell a venue to push back on markets pricing in that the Fed will cut its key rate to around 4% by January 2025. It’s in a range 5.25-5.5% now. 

“The committee is divided,” said Subadra Rajappa, head of U.S. rates strategy for Societe Generale. “The market pricing is showing a lack of conviction. Six cuts are priced in. These are not deep cuts. That’s a high-for-longer story. I cannot see a strong trade here.”

“Minutes of the July 25-26 FOMC meeting, to be released Aug. 16, will show that a majority of Fed officials were encouraged by progress on disinflation, but not yet convinced the rate-hike cycle is over,” said Anna Wong, chief US economist at Bloomberg .

Even so, some investors have been pouring into the Treasury market, drawn by the higher interest rates and concern that this year’s stock market rally is unsustainable. That’s put US Treasuries on course for a record year of inflows, according to Bank of America Corp. strategists.

US Treasuries on Track for Record Year of Inflows, BofA Says

Kerrie Debbs, a certified financial planner at Main Street Financial Solutions, however, has been warning clients that bonds aren’t a sure-fire haven from risk and that the stock market’s push higher may not persist. 

“There are still a whole host of events that could stall these positive market returns, including continuing inflation, perception of credit quality of US government debt, skyrocketing US budget deficits, political instability in the world and more,” said Debbs, who has around 50 clients and manages about $70 million in total assets. 

What to watch

Economic calendar – Aug. 15: Retail sales; Import/export prices; Empire Manufacturing; Business inventories; NAHB Housing Market Index; TIC flows

Aug. 16: MBA Mortgage Applications; building permits; housing starts; industrial production; FOMC meeting minutes

Aug. 17: Jobless claims; Philadelphia Fed Business Outlook; Leading Index

Aug. 18: Bloomberg Aug. US economic survey

Fed calendar

Aug. 15: Minneapolis Fed President Neel Kashkari

Aug. 16: FOMC minutes released

Auction calendar:

Aug. 14: 13- and 26-week bills

Aug. 15: 42-day cash management bills

Aug. 16: 17-week bills

Aug. 17: 4- and 8-week bills

Updated: 13 Aug 2023, 06:27 PM IST