Bond investors are confident that the calm engulfing the Treasury market for months will have a limited shelf life.
A report on May job growth that disappointed some traders did spark a burst of short-covering Friday. But it left intact speculation that the U.S. recovery from the pandemic is strong enough to lead the Federal Reserve to finally start discussions this month around the idea of tapering its massive bond-buying program.
No policy move is expected at the June 15-16 Fed gathering. The options market is coalescing around an actual shift -- with the potential to bust yields out of their volatility-killing range trade -- in August. That’s when the Fed traditionally holds its annual meeting in Jackson Hole, Wyoming, which has served as a venue in the past for important policy signals.
“The Fed at least will acknowledge that they have moved out of the not-even-talking-about-talking-about-tapering to talking about it” this month, said Gene Tannuzzo, a portfolio manager at Columbia Threadneedle.
“Our timeline for an announcement would center on Jackson Hole as a forum to float an academic discussion on the topic” and September as the base case for unveiling a plan to reduce bond buying, setting the 10-year yield up for a likely climb to 2% by year-end, he said.
Hiking Precursor
Tapering looms large for financial markets because the Fed has signaled that it will be a precursor to actual rate increases. While policy makers project that they’ll keep overnight rates near zero at least through 2023, bond traders have been betting for months that liftoff will come early that year.
With investors holding firm on those expectations for now, volatility has been slumping. A measure of future price swings in Treasuries is around the lowest since February. And 10-year yields have traded sideways, pivoting around 1.6% for weeks, after reaching a more than one-year high of 1.77% in March.
The leadup to the Fed’s June 16 decision isn’t devoid of risk. Next week brings a report that’s forecast to show consumer prices accelerated in May at the fastest pace since 2008. That’s after April’s above-forecast reading pushed yields toward the upper end of their recent range. There’s also a $120 billion round of note and bond auctions to absorb next week.
Jeffrey Rosenberg, a senior portfolio manager at BlackRock Inc., also saw May’s job report -- which included robust wage growth -- as leaving the Fed on course to send some signaling in June of a slow movement toward eventually reducing asset purchases.
Seeking Progress
The Fed is currently buying around $120 billion in debt each month -- $80 billion of Treasuries and $40 billion of mortgage-backed securities. The central bank has said it will continue to do so until it has made “substantial further progress“ toward its employment and price goals.
Further out, bets for a shake-up at Jackson Hole have been popping up in the options market, targeting a more aggressive rate outlook for the Fed.
“Until the Fed talks about tapering, or if we get an ugly inflation number, the current yield levels will hold for the time being,” said Gary Pollack, head of fixed-income for private wealth management at Deutsche Bank. “But I expect that yields will be higher by the end of the year, with 10-year yields moving to 2%. The outlook is still bright for the U.S. economy.”
What to Watch
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The economic calendar
- June 7: Consumer credit
- June 8: NFIB small business optimism; trade balance; JOLTS job openings
- June 9: MBA mortgage applications; wholesale inventories/trade sales
- June 10: CPI; jobless claims; real average earnings; Langer consumer comfort; household change in net worth; monthly budget statement
- June 11: University of Michigan sentiment
- The Fed calendar is blank
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The auction calendar:
- June 7: 13-, 26-week bills
- June 8: Cash-management bills; 3-year notes
- June 9: 10-year notes
- June 10: 4-, 8-week bills; 30-year bonds
— With assistance by Edward Bolingbroke
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