Focus point: The Fed building in Washington. Worries are mounting that the central bank has been slow to react in lowering interest rates. — Reuters
New York: Bond traders are piling into bets that the US economy is on the verge of deteriorating so quickly that the US Federal Reserve (Fed) will need to start easing monetary policy aggressively to head off a recession.
Previous worries about the risk of elevated inflation have virtually disappeared, swiftly giving way to speculation that growth will stall unless the central bank starts pulling interest rates down from a more than two-decade high.
That is fuelling one of the biggest bond-market rallies since fears of a banking crisis flared in March 2023.
The advance has been so strong that the policy sensitive two-year Treasury yield tumbled last week by half a percentage point to less than 3.9%.
It hasn’t been that far below the Fed’s benchmark rate – now around 5.3% – since the global financial crisis or the aftermath of the dot-com crash.
The moves extended in Asia trading yesterday with two-year yields slumping more than 10 basis points to 3.77% as bonds rallied across the curve.
“The market concern is that the Fed is lagging and that we are morphing from a soft landing to a hard landing,” said Tracy Chen, a portfolio manager at Brandywine Global Investment Management.
“Treasuries are a good buy here because I do think the economy will continue to slow.”
Bond traders have repeatedly misjudged where interest rates have been headed since the end of the pandemic, however, at times overshooting in both directions and caught off guard when the economy bucked recession calls or inflation defied expectations.
At the end of 2023, bond prices also surged on conviction that the Fed was poised to start easing policy, only to give back those gains when the economy kept exhibiting surprising strength.
So there’s a chance that the latest move is another such swing too far.
“The market is overshooting and getting ahead of itself like we saw late last year,” said Kevin Flanagan, head of fixed-income strategy at WisdomTree.
“You need validation from more data.”
But sentiment has shifted sharply after a string of data showed a softening job market and cooling in segments of the economy.
Last Friday, the US Labor Department reported that employers created just 114,000 jobs in July, far short of what economists were forecasting, and the unemployment rate unexpectedly rose.
After the Fed last Wednesday again held rates steady, the data fanned worries that the central bank has been too slow to react – just as it was in raising interest rates once inflation lingered well after the economy reopened from the pandemic.
That’s been reinforced by the fact that central banks in Canada and Europe have already started easing policy.
Fears of a slowing economy and Fed delays have contributed to a sharp sell-off in US stocks last week, with sentiment further dented over the weekend after Berkshire Hathaway Inc slashed its stake in Apple Inc by almost 50% as part of a massive second-quarter selling spree.
“There’s been an absolutely enormous move in the two-year yield in the past 10 days or so. It’s hard to price a so-called safe-haven asset, it’s much harder to price riskier assets – stocks,” said Steve Sosnick, chief strategist at Interactive Brokers LLC. “And Warren Buffett’s decision to lighten up his Apple position doesn’t help things from a sentiment perspective.”
Economists across Wall Street have started anticipating a more aggressive pace of Fed easing, with those at Citigroup Inc and JPMorgan Chase & Co predicting half-percentage-point moves at the September and November meetings.
Last Sunday, Goldman Sachs Group Inc economists increased the probability of a US recession in the next year to 25% from 15%, but said there are several reasons not to fear a slump.
The economy continues to look “fine overall”, there are no major financial imbalances and the Fed has a lot of room to cut rates and can do so quickly if needed, the economists said.
Futures traders are pricing in roughly the equivalent of five quarter-point cuts through the end of the year, indicating expectations for unusually large half-point moves over the course of its last three meetings.
Downward moves of that scale haven’t been enacted since the pandemic or the credit crisis. — Bloomberg
