The turbulent bond market offers a fleeting glimpse of the end of the cycle

The turbulent bond market offers a fleeting glimpse of the end of the cycle

(Bloomberg) — Bond traders this week got a glimpse of what the eventual end of the Federal Reserve’s lifting cycle might look like.

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Amid volatile trading conditions, Treasuries had their best week since mid-July after several central bank officials noted that the sell-off that pushed yields to multi-year highs was advancing the Fed’s goals in a way that could prevent further tightening. Yields fell as those comments, combined with safe-haven demand fueled by conflict in the Middle East, painted a more supportive backdrop for US bonds.

It was a sharp turn of the face. The rise in yields in recent weeks has seemed unstoppable, with the Federal Reserve’s key interest rate remaining high indefinitely. But despite the week’s rise, many investors are holding on to their expectations of higher interest rates for longer and see the recent gains as fragile. Encouraged by weak demand for Treasury auctions, they are looking for longer-term yields to rise further, eventually returning to above short-term yields, where they have historically been.

“The important thing is to be in a restricted area,” Greg Peters, co-chief investment officer at PGIM Fixed Income, told Bloomberg TV on Thursday. “The curve will continue to normalize. You’ll certainly see the back-end rates move higher, and there’s probably a little room over the next 12 months for the front end to move lower, but not much. I think we have to move to that more normal environment.” “

The fragility of the Treasury market’s advance was clearly visible on Thursday when the gains were swept away by data showing that US inflation remains high, and by weak demand for the 30-year bond auction, despite offering the highest yield since 2007. Another quarter-long increase rebounded. percentage point later this year or by January, while the scope for 2024 interest rate cuts erodes.

Also, while the Fed’s 12th rate hike is still considered less likely than a coin toss, several policymakers said this week they are open to raising interest rates further if necessary.

What Bloomberg strategists say…

“The lion’s share of the recent rise in longer-term yields can be explained by changes in market participants’ perception of the Fed’s monetary policy stance. Risk sentiment and fears of inflationary supply disruptions also play a role.

“October’s mid-month auctions will provide another glimpse into investors’ risk appetite for a further period as Treasury supply narratives continue to weigh on markets.”

—Ana Galvão, chief economist at Bloomberg Intelligence

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Safe-haven demand boosted the market on Friday, as the escalation of war in the Middle East raised fears of a global recession. However, US economic fundamentals remain challenging at present, and the supply of Treasuries is an ongoing source of concern.

Data on Thursday showed that consumer price growth failed to moderate as much as economists estimated in September, while the discrete inflation rate that the Fed is trying to get back to 2% accelerated to 3.5% in August.

Oksana Aronov, head of alternative fixed income market strategy at JPMorgan Asset Management, told Bloomberg TV on Thursday that even at the recent peak of 4.88%, the 10-year bond yield “is still largely priced in to a 2% inflation world.” %”. . “So I wouldn’t be surprised if the 10-year period exceeds 5%.”

As for supply, the volume of Treasury auctions for the August-October quarter increased for the first time in more than two years, and another round of increases is expected for the November-January period, to be announced on November 1. .

Expanding borrowing at a time of low unemployment “is a very worrying and really unusual situation at this point in the cycle,” said Gene Tanuzzo, global head of fixed income at Columbia Threadneedle. He is also concerned about the possibility that oil prices will continue to put upward pressure on inflation and long-term yields.

Read more: Pimco sees bonds benefiting as markets overlook recession risks

However, this week’s short notice has highlighted the risks inherent in stashing cash while waiting for long-term yields to peak — the profitable path for most of the past three years.

“I feel like clients still prefer shorter durations because fixed income has been so painful for a long time now,” said Baylor Lancaster Samuel, chief investment officer at Amerant Investments. Although we don’t know exactly when that will happen, I’ve never been more excited about fixed income in the two decades I’ve been on the Street.

what do you want to watch

  • Evaluation of economic data

    • October 16: Imperial Manufacturing; Monthly budget statement

    • October 17: Retail sales. Industrial production international capital flows to the treasury

    • October 18: Applications for Master of Real Estate Business Administration; Begins housing Beige Fed Book

    • October 19: Initial jobless claims, Philadelphia Fed business outlook; Existing Home Sales; Leading indicator

  • Fed calendar

    • October 16: Philadelphia Federal Reserve Bank President Patrick Harker

    • October 17: New York Federal Reserve Bank President John Williams; Federal Reserve Governor Michael Bowman; Richmond Fed President Tom Barkin; Minneapolis Federal Reserve Bank President Neel Kashkari

    • October 18: Fed Governors Christopher Waller, Bowman, and Lisa Cook; Williams, Parkin and Harker

    • October 19: Federal Reserve Vice Chairman Philip Jefferson and Federal Reserve Chairman Jerome Powell; Chicago Federal Reserve Bank President Austin Goolsbee; Atlanta Federal Reserve Bank President Rafael Bostic; Harker. Dallas Federal Reserve Bank President Lori Logan

    • October 20: Harker; Cleveland Federal Reserve Bank President Loretta Mester

  • Auction Calendar:

    • October 16: 13 and 26 week bills

    • October 17: Cash management invoices for 42 days

    • October 18: 17 weeks billing; 20-year bonds

    • October 19: 4 and 8 week bills; Tips for 5 years

– With the assistance of Edward Bolingbroke.

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