(Bloomberg) — The bond market is finally aligning with Jerome Powell’s economic outlook.
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Traders are optimistic that Fed chiefs will turn to accommodative policy by the end of the year, reflecting a sharp drop in expectations that central bank rate hikes are poised to trigger a sharp recession. I canceled my bet. Bond yields have risen to pre-silicon valley panic levels.
And unlike the European economy, which is showing signs of slowing, the U.S. economy is expected to hold up pretty well, even though policymakers see two more rate hikes in the next few months. ing.
“There’s a growing perception that the Fed won’t cut rates this year,” said Greg Peters, co-chief investment officer at PGIM Fixed Income. “It’s kind of an ‘aha’ moment when the market is priced in that what the central bankers say is what they mean.”
US Economy Avoids Recession, But Inflation Expected to Continue
On Friday, the S&P Global Purchasing Managers’ Index showed growth in the euro zone had largely stalled this month, but the U.S. continued to grow, albeit at a slower pace, highlighting the divergent outlook between the U.S. and Europe. The news prompted investors to take refuge, U.S. Treasury gains narrowed, and Europe’s sovereign bond market accelerated its massive rally.
Nonetheless, the figure highlights the risk that slowing global growth could weigh on the United States. And markets have expected the economy to slow even if the U.S. narrowly avoids a recession this year.
After Powell told lawmakers this week that more interest-rate hikes are possible, 10-year yields plunged to well below 2-year yields, deepening the inversion usually seen as a harbinger of recession. turned into However, this was primarily due to short-term interest rates rising while long-term interest rates remained largely unchanged.
Swap traders have postponed expected rate cuts until next year, but expect the Fed’s key rate to remain high enough to constrain growth. That means policymakers are still expected to focus on inflation rather than accelerating growth.
“We will do whatever it takes to bring inflation down to 2% over time,” Powell told the Senate Banking Committee on Thursday. He said there could be two more rate hikes this year and that he doesn’t think a rate cut “will happen anytime soon.”
Powell will speak at several global events next week and could give further insight into the policy outlook.
The Fed’s favorable inflation readings on Friday are expected to show some improvement in May after an unexpectedly high reading in April, a result that has given bond traders a more sober look ahead. will give more momentum to Already, short- and long-term consumer price inflation expectations have stabilized at just over 2% since early May on hopes that the Fed will succeed in its mission.
The consumer spending price index is expected to slow to an annualized 3.8% in May from 4.4% in April, according to a survey of economists compiled by Bloomberg. Core indicators, which exclude food and energy, are expected to stabilize again at the 4.7% level.
“If you look at some of the U.S. inflation indicators, they are clearly down,” Thierry Wisman, global rates and currency strategist at Macquarie, told Bloomberg Television. “In the second half of the year, we will see the so-called ‘persistence’ in ‘some inflation indicators’ finally recede and begin to decline. I think the market understands that too. ”
Bond market volatility is less severe as uncertainty about the outlook fades. It’s also a boon for traders, many of whom are entering 2023 expecting a good year for bonds, with bonds up about 1.6% and recovering slightly from big losses in 2022.
The ICE BofA MOVE index, a key indicator of expected Treasury volatility, has nearly halved since March, when it hit its highest level since 2008.
Traders now see another quarter-point rate hike likely in July, giving the Fed a chance for further hikes. The Fed’s policy rate is expected to peak at about 5.35% this year before the U.S. central bank raises rates to about 3.8% by December 2024, a level that would still slow economic growth. This level is considered to be sufficiently high.
“Given what we’ve done so far, it may make sense to raise interest rates, but the pace will be slower,” said Jared Gross, head of institutional portfolio strategy at JPMorgan Asset Management. It’s a thing,’ he said.
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–With help from Ye Xie.
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