Powell convinces bond traders to dial bets on a deep downturn

(Bloomberg) – The bond market is finally in sync with Jerome Powell’s economic outlook.

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Traders abandoned once-aggressive bets that the Federal Reserve chief would shift to easing policy before the end of this year, reflecting deeply diminished expectations that central bank rate hikes are about to unfold. trigger a deep recession. Bond yields have risen to levels seen before the panic caused by the collapse of the Silicon Valley Bank.

And even if policymakers see a chance for two more rate hikes in the coming months, the US economy should hold up reasonably well, unlike Europe, which is showing signs of slowing.

“We realize that the Fed is not going to cut interest rates this year,” said Greg Peters, co-chief investment officer at PGIM Fixed Income. “It’s kind of an ‘ah-ha’ moment being priced in by the market that central bankers mean what they say.”

US economy on the fringes of recession but with persistent inflation

The diverging outlook in the United States and Europe was underscored on Friday, when the S&P Global Purchasing Managers Indices indicated that growth nearly stalled in the euro zone this month, but continued in the United States. United, although at a slower pace. The reports fueled a strong rally in the European government bond market as investors turned to safe havens, with US Treasuries posting weaker gains.

Nevertheless, the figures highlighted the risk of a slowdown in global growth which would weigh on the United States. And markets are anticipating a slowing economy, even though the United States only narrowly avoids a recession this year.

After Powell told U.S. lawmakers this week that more rate hikes were likely, 10-year yields slipped a full percentage point below 2-year rates, deepening an inversion in the yield curve that is generally considered the harbinger of a recession. But that was largely due to a rise in short-term rates, with longer-term rates little changed.

While swap traders have postponed expected cuts to next year, they expect the Fed’s key rate to remain high enough to dampen growth. This means that policymakers should always focus on inflation, not on reviving growth.

Powell told the Senate Banking Committee on Thursday that “we will do what it takes to bring inflation down to 2% over time.” He said two more rate hikes were possible this year and he didn’t see a rate cut “happening any time soon.”

Powell will speak next week at several global events, potentially giving more insight into the policy outlook.

Friday’s release of the Fed’s favorite inflation indicators is expected to show some improvement in May after surprisingly warm April readings, a result that would provide additional momentum for bond traders who see more calm ahead. Already, short-term and long-term consumer price inflation expectations have held steady at just over 2% since early May in anticipation of the success of the Fed’s mission.

The personal consumption expenditure price index is expected to slow to an annual rate of 3.8% in May from 4.4% in April, according to economists polled by Bloomberg. The core measure, which excludes food and energy, is expected to hold steady again at 4.7%.

“If you look at some of the inflation indicators in the US, they’re clearly down,” Thierry Wizman, global interest rate and currency strategist at Macquarie, told Bloomberg TV. “In the second half of the year, you’re finally going to see this so-called stickiness that we’re seeing in ‘multiple inflation indices’ start to pull back and come down. I think the market understands that.

With the outlook becoming less uncertain, bond market fluctuations have been less severe. It’s also a positive sign for traders, many of whom entered 2023 predicting a better year for bonds, which gained around 1.6%, rebounding slightly from the steep losses of 2022.

The ICE BofA MOVE Index, a closely watched indicator of expected Treasury swings, has fallen nearly half since March, when it hit its highest level since 2008.

Traders now see another quarter-point rise in July as likely and are giving another a chance. The Fed’s key rate is expected to peak this year at around 5.35% before the U.S. central bank pushes rates to around 3.8% by December 2024, a level that is still considered high enough to slow growth. economic growth.

“Given how far we’ve come, it may make sense to raise rates, but do so at a more moderate pace,” said Jared Gross, head of institutional portfolio strategy at JP Morgan Asset Management.

What to watch

–With the help of Ye Xie.

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