bond markets crucial juncture the inflation battle key to yield trajectory 146

Market Trends

Bond Market's Crucial Juncture: The Inflation Battle Key to Yield Trajectory


Lauren Miller

April 7, 2024 - 19:22 pm


Bond Market's Last Hope Pivots on Inflation Battle as Fed Holds Steady

(Bloomberg) -- As the bond market reels from this year’s precipitous downturn, traders are pinning their dwindling optimism on a pivotal sign: the Federal Reserve's success in taming the surging inflation rates. The unexpectedly robust U.S. economy has propelled Treasury yields to their highest levels since the tail end of November, with investor sentiment shifting away from anticipations of interest rate cuts. These forecasts have changed as the policymakers show caution to avoid hasty policy relaxation.

Friday's market downturn came on the heels of data that revealed a significant surge in U.S. payrolls in March, marking the most considerable expansion in nearly a year. This has left the investment sector eyeing the upcoming consumer-price index (CPI) report on Wednesday with bated breath, as it is poised to dictate the direction of yields – whether they stabilize or climb to new highs. The 10-year rate has become a focal point, with many seeing the 4.5% mark as the next critical threshold, just slightly above its closing level on Friday.

Yields are currently teetering, as Kevin Flanagan, head of fixed-income strategy at WisdomTree, outlines, "A lot hinges on the CPI number — it could confine yields within the 4% to 4.5% bracket, or prime us for a more substantial ascent." He voiced concerns that the main risk for the bond market lies in a combination of steady job growth and stalling inflation improvements.

The Treasuries have struggled to find stable footing throughout the year as the economy consistently disproved pessimistic predictions. This resilience has not only buoyed stocks but instigated another bout of losses within the bond sector as yields have punctured the levels where stability was previously anticipated.

Fed Chair Jerome Powell has reinforced that adjustments to the policy will come only when there is substantial confidence that inflation will steadily converge towards the 2% goal. Powell also stated that while the central bank has factored in interest rate cuts in the year, there is readiness to intervene should there be an unforeseen slump in the job market.

The economy's persistent expansion has placed additional pressure on longer-dated bonds by heightening inflation concerns. T. Rowe Price Group's fixed-income portfolio manager, Stephen Bartolini, initially expressed readiness to capitalize should the 10-year yields exceed 4.4%. However, the recent strength of the economy has led him to rethink and adopt a more cautious stance, anticipating even higher yields.

"The recent data has been decidedly more robust than expected, which reflects in market performance over the past week," Bartolini commented. "What has taken many by surprise is the stickiness of inflation indicators."

A recent report from Bloomberg Intelligence suggests that if the yield selloff persists towards 4.51% over the forthcoming week, momentum indicators could enter a domain consistent with a market pause or a partial retracement. Any break past the 4.51% threshold would set sights on the early November 2023 yield high at 4.7%, as per BI strategists Ira F. Jersey and Will Hoffman.

For a deeper dive into the report, readers can click here to read the full analysis provided by Bloomberg Intelligence.

The forthcoming CPI data, due on Wednesday, is projected by economists to exhibit some moderation in inflationary pressures. Based on Bloomberg economist surveys, both the comprehensive and core metrics — which exclude volatile food and energy costs — are thought to have risen by 0.3% in March, diminishing from a 0.4% advancement in February. Nonetheless, this would keep the core CPI elevated approximately 3.7% year-over-year, starkly above the Federal Reserve's comfort zone, especially amidst concurrent hikes in oil prices.

If the upcoming inflation figures match or fall beneath these projections, it may act to steady yields or even draw them down from their current levels. Contrarily, should the reading exceed expectations, the bond market might brace for another wave of sell-offs. Certain money managers, such as Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investment, speculate that institutional investors may aggressively re-engage if the 10-year rate climbs beyond 4.5%.

Priya Misra, a portfolio manager at JPMorgan Asset Management, suggests that the time is already ripe for pivoting towards 10-year notes. Misra highlights that, despite the strong labor market, wage gains remain subdued, indicating that the demand for labor is not exerting excessive inflationary pressure.

Misra's current strategy aligns with this market reading: "My strongest conviction at the moment is to slowly transition into 10-year bonds."

Economic indicators and events that are keenly watched by the market include:

  • Economic data:
    • April 8: New York Fed 1-year inflation expectations
    • April 9: NFIB small business optimism
    • April 10: MBA mortgage applications; Consumer price index; real average hourly and weekly earnings; wholesale inventories; monthly budget statement
    • April 11: Producer price index; initial jobless claims
    • April 12: Import and export price index; U. of Mich. sentiment and inflation expectations
  • Federal Reserve's Calendar:
    • April 8: Minneapolis Fed President Neel Kashkari
    • April 10: Governor Michelle Bowman; Chicago Fed President Austan Goolsbee; FOMC meeting minutes from March
    • April 11: New York Fed President John Williams; Boston Fed President Susan Collins; Atlanta Fed President Raphael Bostic
    • April 12: Bostic; San Francisco Fed President Mary Daly
  • Auction calendar:
    • April 8: 13-, 26-week bills
    • April 9: 42-day cash management bills; three-year note
    • April 10: 17-week bills; 10-year notes
    • April 11: 4-, 8-week bills; 30-year bonds

These events and data releases are vital for investors to monitor as they may provide further insights into the direction of interest rates and the bond market as a whole.

©2024 Bloomberg L.P. The information presented in this article has been derived from reputable sources and is delivered with the aim of providing readers with comprehensive market insights.

In conclusion, the bond market sits at a juncture where the forthcoming CPI report will likely serve as a critical determinant of the near-term trajectory for yields. With the Federal Reserve maintaining a vigilant stance against premature policy shifts, the investment community remains on alert, ready to adapt to the evolving economic landscape. As the tussle with inflation persists, all eyes will be trained on Wednesday's CPI data for clarity on whether the bond market can finally catch a much-needed respite or brace for continued volatility.