Bond traders are left to debate Fed pivot as rate-cut bets grow

After a week in which the bond market shifted to betting that an interest-rate cut is the Federal Reserve’s likely next move, traders still see plenty of room for debate.

Gene Tannuzzo at Columbia Threadneedle Investments, for one, is on board with the market’s stance, amid slowing global growth and tame inflation. Michael Collins of PGIM Fixed Income, on the other hand, isn’t ready to rule out a rate hike this year, especially after signs of strength in economic data Friday.

The showdown between the two camps may persist with key economic data still delayed because of the lingering effects of the government shutdown. That means appearances by Fed Chairman Jerome Powell and other policy makers may loom large in the days ahead as investors parse their comments for signs officials view the market as leaning too far toward easing.

“It will be interesting to hear the Fedspeak in the next few weeks,” said Tannuzzo, deputy global head of fixed income. “They need to clarify the risks to US growth from the foreign slowdown. This has not been clear so far.”
 

Benchmark 10-year Treasury yields fell as low as 2.62 percent on Thursday, the day after Powell said the case for further rate hikes has weakened. However, a one-two punch of stronger-than-anticipated US payroll and manufacturing figures sent 10-year yields back to 2.68 percent on Friday. Traders now see a steady Fed in 2019 and about 15 to 20 basis points of easing next year; a week ago, futures indicated some chance of tightening in 2019.
 

‘Shock’ Ahead?
 

Friday’s data help explain why Collins finds it premature to discount the possibility of additional tightening in 2019, which in his view sets up markets for “a bit of a shock.” Continued strength in consumer-focused reports such as retail sales could prompt policy makers to press on with their projected hikes, according to Collins, whose firm manages $729 billion.
 

“The consumer’s in good shape,” said Collins, a senior portfolio manager. “Data will continue to be supportive of the markets, of the economy, and probably put a little pressure on the front end of the yield curve.”
 

Tannuzzo isn’t so sure. For him, a more likely scenario is that slowing US growth and subdued inflation will further erode expectations for another hike. Indeed, Friday’s jobs report showed little sign of wage pressures -- despite the headline beat, average hourly earnings rose 0.1 percent on a monthly basis, versus an expected 0.3 percent increase.
 

“The question is, did we see the last hike in December 2018? We think those odds are growing,” Tannuzzo said. “If inflation expectations keep drifting lower, the Fed will have trouble restarting hikes.”
 

He’s keeping an eye on the data for signs of a slowdown, and he expects reports such as retail sales and personal income will likely “get worse before they get better.” And outside the US, potential spillover effects from US-China trade friction will likely impede tightening, he said.
 

That fraught geopolitical backdrop -- combined with concerns about the global economic outlook -- stand to intensify bond traders’ focus on Fed officials.

What to Watch
 

• In addition to Powell’s appearance, next week also brings President Donald Trump’s delayed State of the Union address Tuesday and a Bank of England meeting Thursday
   
• Economic data include:
   
• Feb. 4: Factory orders; Fed senior loan officer opinion survey
• Feb. 5: Markit US services PMI; ISM non-manufacturing
• Feb. 6: Mortgage applications; trade balance
• Feb. 7: Jobless claims; Bloomberg consumer comfort; consumer credit
• Fedspeak picks up:
• Feb. 3: Minneapolis Fed’s Neel Kashkari at town hall
• Feb. 4: Cleveland Fed’s Loretta Mester on the economic outlook and monetary policy
• Feb. 6: Vice Chairman for Supervision Randal Quarles discusses Fed stress-testing conference; Powell hosts town hall meeting with educators
• Feb. 7: Fed Vice Chairman Richard Clarida discusses a paper he wrote on the global factor in neutral policy rates; St. Louis Fed’s James Bullard on the US economy and monetary policy
• Feb. 8: San Francisco Fed’s Mary Daly at economic forecast conference
   
• The market will have Treasury auctions to absorb:
   
• Feb. 4: $45 billion of 3-month bills; $39 billion of 6-month bills
• Feb. 5: $38 billion of 3-year notes
• Feb. 6: $50 billion of 18-day cash-management bills; $27 billion of 10-year notes
• Feb. 7: 4- and 8-week bills; $19 billion of 30-year bonds