Bond Traders Brace for Fed Meeting Fraught with Wildcards, Risks

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(Bloomberg) — The risks to bond investors from next week’s Federal Reserve meeting extend beyond whether officials decide to raise interest rates again.

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For a market that has been betting that the central bank will soon be heading for a rate cut, its updated quarterly forecasts for policy rate and key economic indicators — due for release Wednesday at the same time as its interest rate decision — will be at least as important.

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The interest rate decision is of course crucial, especially as traders remain divided on whether a hike is likely in June or July. But there is more riding on the policy path after that point.

The Fed has insisted it is too early to consider rate cuts this year, and traders are no longer expecting more than one cut. However, there are a lot of bets in options and elsewhere that an economic slowdown will require lower borrowing costs.

So the FOMC members’ economic outlook and Chairman Jerome Powell’s tone during his post-decision press conference may shape the response more than the timing of the next quarter-point rally. If they suggest that conditions are peaking, the bets on the pivot will increase, while the group of more aggressive and hawkish forecasters will stimulate bets on higher rates for longer.

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“The market is positioned to go higher over the longer term,” said Megan Sweber, interest rate analyst at Bank of America Corp., referring to the part of the market that benefits most from declining yields, and the final thing that supports that view is that the Fed has Finished the hiking course.”

Sweber said that asset managers who favor long-term Treasury bonds or set for a steeper yield curve anticipate the end of the Fed’s rate hikes. Bank of America’s latest monthly survey of investor sentiment found exposure to the US dollar at its highest level since 2004, after passing pandemic highs in April 2020.

Swaps linked to future meetings of the Federal Reserve — which were priced almost entirely at the end of May up a quarter point in June — lowered that score to about one in three — and there was still an unusual lack of consensus shortly before the event. The Fed has raised interest rates 10 consecutive times since March 2022, and in all but two cases, swap pricing has reflected little skepticism about the likely outcome.

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The July contract priced at around 5.31% is about 23 basis points higher than the 5.08% level of interest rate targeting by the Fed, with pricing almost entirely up by 25 basis points by then. For December, the contract rate is 5.07%, and any quarter-point increase in the rate from the current level is expected to be reversed by the end of the year.

“The Fed is pretty much done even if it goes one or two more times,” said Arvind Narayanan, senior portfolio manager at Vanguard Group Inc. Slow enough to keep interest rates at 5% for the rest of the year, and then the Fed slowly tapers off next year.”

What do bloomberg strategists say

It is already rare for the Fed to retighten policy after a pause. It’s rare to do that when prices are already constrained.”

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Simon White, Macro Strategist

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Inflation data to be released early on Tuesday could be decisive. CPI growth is expected to slow to 4.1% in May from 4.9%, and to 5.2% from 5.5% excluding food and energy. The Fed seeks an inflation rate that will average 2% over time.

Economists at Citigroup Inc. said: , who expect a rate hike in June, are looking forward to May CPI readings that they expect to show core inflation remains closer to 5%, Andrew Hollenhorst, the bank’s chief US economist, said in a video released. Thursday.

Before the meeting, signals from the treasury market may be distorted by an unusually large amount of new supply squeezed in two days. In addition to the monthly sales of 3-, 10- and 30-year notes, which are usually spread out over three days, $206 billion in Treasury securities is scheduled to be sold to replenish government coffers, which were depleted until the federal debt limit was suspended last week.

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Expectations for more Fed rate hikes peaked this year in early March, when Powell said policymakers were ready to re-accelerate the pace of interest rate increases if economic data warranted. The two-year Treasury yield, which is more sensitive than the longer maturities to changes in the Fed rate, briefly exceeded 5%. It held steady around 4.6% as the case for rate hikes softened due to several regional bank failures and other signs that the economy may finally reckon with tighter financial conditions.

“We think the Fed is likely to skip into July,” said Thomas McLoughlin, head of fixed income for the Americas at the principal investment desk at the wealth management arm of UBS Group. “But Powell’s message was that his intention is to maintain tight monetary policy at least until the end of the year and possibly even next year.”

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what do you want to watch

• Economic data calendar
  • June 12: Monthly budget statement
  • June 13: Consumer Price Index. NFIB Small Business Optimism
  • June 14th: Mortgage Applications for MBAs. producer price index
  • June 15th: Retail Sales. unemployment claims; indexes of import and export prices; manufacturing empire business forecasts for the federal reserve bank of philadelphia; Industrial production; business inventory; International capital flows to the treasury
  • June 16: Federal Services Business Activity in New York. U of Michigan sentiment and inflation expectations
• Federal Reserve calendar
  • June 14: FOMC Policy Decision. Summary of economic forecasts. Press conference chair Jerome Powell
• Auction calendar
  • June 12: Bills 26 and 13 weeks old; 3 and 10 year bonds
  • June 13: 52-week bills; 42-day cash management billing; 30 year bonds
  • June 14th: 17-week billing
  • June 15th: 4th and 8th week bills

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