Bruised by their last encounter with robust US employment data, some bond investors have retreated into a guarded market outlook ahead of next week’s February jobs report: that short-maturity Treasury yields will widen their advantage over long-dated ones.
(Bloomberg) — Bruised by their last encounter with robust US employment data, some bond investors have retreated into a guarded market outlook ahead of next week’s February jobs report: that short-maturity Treasury yields will widen their advantage over long-dated ones.
Yields across the Treasury maturity spectrum reached 2023 highs this week, with the 30-year bond’s briefly joining shorter-dated yields above the 4% threshold. The shift reflects the view that the Federal Reserve is likely to raise interest rates more than previously anticipated to keep inflation on the run.
Because short-term debt is more sensitive to changes in the Fed’s rate, two-year yields peaked closer to 5% this week, at 4.94%, the highest since 2007. While yields at or approaching multiyear highs are tempting some investors to buy, the possibility of still-higher ones ahead highlights the appeal of wagers that the gaps between short and long maturities will widen further.
As traders pushed the consensus on the peak Fed rate to 5.5%, from a current band of 4.5%-4.75% — with some taking a flier on 6% — two-year Treasury yields exceeded 10-year ones by as much as 91 basis points, while the five- to 30-year gap widened to 39 basis points, both close to the biggest in decades. These inverted yield curves embed a view that high short-term rates are going to break the economy.
“Moving to 6% increases the chance of an error of some kind,” said Nils Overdahl, a senior portfolio manager at New Century Advisors. “In that case, the Fed is not likely to keep rates at their peak for as long.”
That line of thinking helps explain why, even as the expected peak rate has increased from under 5% at the start of the year, swap contracts referencing Fed meeting dates continue to price in roughly 50% odds that the central bank will lower its policy rate by a quarter point from the peak by the end of the year. As recently as early February, however, the contracts were fully pricing in two quarter-point cuts.
Next week’s February employment report — along with other labor-market indicators including JOLTS job openings and initial claims for jobless benefits — is likely to be pivotal, said John Madziyire, portfolio manager at Vanguard Group Inc.
“We need to see whether it validates recent strength in the economy or not,” he said. So far “the repricing has mainly been driven by the front end and that means you do get a flattening of the yield curve.”
Also in the mix next week are Treasury auctions of three- and 10-year notes and 30-year bonds with the potential to push yields in those sectors temporarily higher, and Fed Chair Jerome Powell’s semiannual congressional testimony on monetary policy Tuesday and Wednesday.
While the market’s base case continues to be for quarter-point rate hikes at each of the Fed’s next three meetings, the first one on March 21-22, former Treasury Secretary Lawrence Summers and former White House chief economist Jason Furman said Friday the Fed should consider reverting to a half-point increase this month.
Any sense from Powell that he’s receptive to that view “will increase the curve inversion,” said Greg Peters, co-chief investment officer PGIM Fixed Income.
The repricing so far also anticipates that the monetary policy forecasts Fed policy makers release quarterly will be higher in March than in December, Peters said.
“The curve is telling you inflation is still sticky, but rate hikes will have an effect at some point.”
What to Watch
- Economic calendar
- March 6: Factory orders
- March 7: Wholesale trade sales and inventories; consumer credit
- March 8: MBA mortgage applications; ADP employment change; trade balance; JOLTS job openings
- March 9: Jobless claims; Challenger job cuts
- March 3: Employment; monthly budget statement
- Fed calendar
- March 7: Fed Chair Jerome Powell testimony, Senate Banking Panel
- March 8: Powell testimony, House Financial Services Committee
- Auction calendar:
- March 6: 13-, 26-week bills
- March 7: 3-year notes
- March 8: 10-year notes; 17-week bills
- March 9: 30-year bonds; 4-, 8-week bills
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