Maintaining silence: Powell speaking about the semi-annual Monetary Policy Report to the Congress in Washington. There’s a school of thought that says the central bank chairman will steer away from pointing to any specific meeting for the first cut. — Reuters
NEW YORK: Bond traders who’ve set themselves up for gradual interest rate cuts starting in September are ramping up side bets in case a sudden slide in the US economy forces the US Federal Reserve (Fed) to be even more aggressive.
As treasuries advanced for a third-straight month, investors are fully pricing in at least two quarter-point rate reductions this year, slightly more than what policymakers have telegraphed.
In the derivatives market, some traders have gone even further with wagers that pay off if central bankers go bold and deliver a half-point cut in mid-September, or start lowering rates sooner.
While still an outlier scenario, speculation around the need for such a move has gained traction amid evidence that companies and consumers are feeling the pinch from two-decade-high benchmark rates.
Even as inflation has ebbed, investors are increasingly concerned the labour market is about to crack, something Fed officials said they’ll be attuned to.
The sizeable time gap between the July policy meeting and September’s adds risk to the equation.
“It’s fair to say that if labour shows more signs of weakening, then the economy is in worse shape and that gets the Fed to cut more,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management.
“What we don’t know is what kind of cutting cycle it will be.”
Anxiety reached a new level last week, when former New York Fed president William Dudley and Mohamed El-Erian said the Fed risks making a mistake by holding rates too high for too long – with Dudley even calling for a move at this week’s policy meeting. Both were writing as Bloomberg Opinion columnists.
The commentary alone was enough to roil the market, sending policy-sensitive short-term US yields tumbling in a so-called steepening pattern, as is customary before an easing cycle.
Still, eco-friendly data on jobless claims, US growth and consumer spending helped support the case for the central bank to hold tight this week.
“The data removes the urgency for the Fed to have to act,” Michelle Girard, head of US at Natwest Markets, said. “The Fed does not want to appear panicked.”
Anticipation of imminent rate cuts has buoyed treasuries overall, sending yields markedly lower from peaks set in late April, despite some recent turbulence sparked by election concerns.
A Bloomberg index of US government debt touched a two-year high this month and is poised to end July on a three-month winning streak last seen in mid-2021.
Policymakers have left their target rate at 5.25% to 5.5% for a year while awaiting signs of a sustained cooling in inflation.
With prices seemingly headed in the right direction, data released last Friday showed the Fed’s preferred measure of inflation rose at a tame pace in June, they’ve begun placing more emphasis on the other side of their so-called dual mandate: full employment.
On that front, the coming couple of months will be crucial, including next week’s jobs report.
Evidence of material weakness “may bring renewed questions about the soft landing and perhaps the Fed falling back behind the curve and missing the opportunity to have cut rates in July”, said George Catrambone, head of fixed-income at DWS Americas.
With the Fed expected to stand pat, chairman Jerome Powell could use his press conference to raise fresh economic concerns or policy changes. — Reuters
