The bond market is overhauling its bets on the path of US interest rates the day before the Federal Reserve concludes its pivotal monetary-policy meeting.
(Bloomberg) — The bond market is overhauling its bets on the path of US interest rates the day before the Federal Reserve concludes its pivotal monetary-policy meeting.
Short-term Treasury note yields jumped to the highest since March amid waning expectations that the central bank will cut rates this year. Traders also adjusted their view on Wednesday’s key Fed decision, signaling higher conviction that officials will leave rates steady after data showed consumer-price gains last month were in line with forecasts.
Swaps traders lowered to about 10% the probability of an 11th straight increase in the main US policy rate Wednesday, from the current range of 5% to 5.25%. While they also trimmed the odds of a quarter-point increase in July, that outcome is still judged to be likelier than not as inflation remains elevated.
“They have the option” this week “to skip,” Abby Joseph Cohen, former senior investment strategist at Goldman Sachs Group Inc., said on Bloomberg Television. “They have already done so much. I would vote for a wait and watch.”
A key shift in market expectations centered on the December swap contract, as it rose to 5.15%, and was trading above the current effective fed funds rate of 5.08%. While the December swap remains below July’s peak of 5.29%, the prospect of a hawkish policy outlook from Fed officials via their so-called dot plot, to be released Wednesday, weighed on market sentiment.
“The market has aptly priced in a slightly higher dot plot,” said Dan Mulholland, senior managing director at Crews & Associates. “The hawkish part will likely be the idea that they will stay on hold for quite some time before reversing monetary policy.”
After yields initially fell on signs of cooler inflation, the front end saw relentless selling, sending yields out to the five-year sector higher by 12 basis points. In SOFR options, traders appeared to exit wagers hedging Fed rate cuts this year into early next year.
The two-year yield dropped as much as 9 basis points to 4.49% before stabilizing and going on to plow higher as traders scaled back the likelihood the Fed will cut rates before the end of the year. The yield briefly exceeded 4.7 for the first time since March. The five-year note swung from a post-CPI low of 3.815% to rise back over 4% for the first time since March.
What Bloomberg Economics says:
“May’s CPI likely won’t alter policymakers’ inclination to temporarily pause their rate-hike campaign at the June 13-14 FOMC meeting.
Still, price gains are easing so slowly that those expecting rate cuts later this year are likely to be disappointed.”
—Anna Wong, chief US economist
—Read full report, here
Treasuries initially began reversing their CPI-related gains ahead of an auction of 30-year bonds. The 30-year yield was 5 basis points higher at 3.94% late in New York and lagged the front-end selloff, and the $18 billion auction was well supported.
The consumer price index climbed 4% in May from a year earlier, for the smallest increase since March 2021. Excluding housing and energy, service prices climbed 0.2% from a month earlier, more consistent with prepandemic trends, according to Bloomberg calculations.
The market’s reaction was exaggerated by wagers on higher rates, said Ed Al-Hussainy, global rates strategist at Columbia Threadneedle.
The bond market “was a bit short into this meeting, and the knee-jerk reaction is a relief rally in rates,” he said. Still, “the underlying thesis playing out is that there is not much in this data to compel them to hike tomorrow.”
Elsewhere, UK government bonds declined after a stronger-than-expected job report prompted investors to boost bets that the Bank of England would push borrowing costs toward 6% by early next year. At 4.43%, the 10-year gilt yields are about 60 basis points above US 10-year rates, marking the biggest gap since 2009.
–With assistance from Ye Xie, Elizabeth Stanton and Mark Tannenbaum.
(Updates market moves and adds Bloomberg Economics comment.)
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