US bond traders worried about rest of 2019

Bloomberg New York | Updated on July 14, 2019 Published on July 14, 2019

Bond traders appear certain that the Federal Reserve is on the brink of its first rate cut since 2008. The biggest question is: what comes next?

Federal Reserve Chairman Jerome Powell last week opened the door to a July cut, stressing a cooling global economy and trade friction as drivers. That leaves investors monitoring US retail sales figures this week and the latest economic data out of Europe and Asia to fine-tune wagers on the extent of cuts for the rest of 2019.

Futures imply a quarter-point July Fed cut and a total of almost 70 basis points of easing for all of 2019. Last week showed how shifting expectations for the Fed’s path amid thin summer trading can jolt markets: The yield curve from two to 10 years steepened the most since October as rate-cut bets gained momentum, while June inflation data beat forecasts.

“Global growth and domestic inflation is really the key for the Fed now,” said Gennadiy Goldberg, a senior US rates strategist at TD Securities. “There’s a very low bar for the Fed to cut once or twice, but there’s a lot of possible permutations after that.”

This week is the last chance for policy makers to sway the market before the Fed’s standard quiet period begins in the lead-up to its July 30-31 meeting. Powell is scheduled to speak in Paris, and New York Fed President John Williams is among others scheduled to appear.

Steeper curve

The prospect of an imminent Fed easing and reports showing above-forecast US inflation drove the curve steeper last week. The gap between two- and 10-year notes expanded about 10 basis points, to 27, back toward the years peak levels. Two-year yields fell to 1.85 per cent, while 10-year rates rose to 2.12 per cent.

TD predicts a further steepening in the next three to six months. It forecasts quarter-point cuts in July, September and October, followed by 75 basis points of reductions in 2020.

There is another reason to expect longer maturities to lag: Auctions last week showed investors starting to balk at yields near the lowest this year as the Fed signalled that it was preparing to add stimulus.

“Front-end yields can’t really rise given a July cut is baked in the cake,” said John Briggs, head of Americas strategy at NatWest. “But given positioning and the recently poor 30-year auction, we could see more selling pressure in the long-end that causes more steepening.”

“The 10-year yield may rise this week to the next support level, at about 2.2 per cent,” he said. NatWest forecasts quarter-point cuts in July and September and then for the Fed to stand pat.

Debt concern

It is not all about the Fed this week. Traders are also assessing the looming risk around the nation’s debt limit, after Treasury Secretary Steven Mnuchin warned that the government may run out of cash in early September if Congress does not raise the US borrowing authority.

Investors are signalling concern. Treasury bills maturing around mid-September through early October yield more than later maturities as buyers avoid securities that could be at risk of non-payment if Congress does not lift or suspend the debt cap.

Published on July 14, 2019
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