Great Treasury Market Recession Trading Gains Momentum

Great Treasury Market Recession Trading Gains Momentum

(Bloomberg) – The bond market is focused on a U.S. recession next year, with traders betting that the longer-term path for interest rates will be down even as the Federal Reserve is still busy raising its benchmark rate. .

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Long-term Treasury yields are already below the Fed’s overnight benchmark range – currently 3.75% to 4% – and there is still an additional percentage point of central bank increases. In the coming months. Activity also emerged in the options market, suggesting that some are hedging against the risk that policy rates could eventually halve from their current level.

Rather than wait for conclusive economic evidence that this year’s frenzied monetary tightening will lead to recessionary conditions in 2023, investors have been buying bonds – a stance advocated by Pacific Investment Management Co., among others.

“Fed policy is aggressive and they’re always signaling they’re going to go higher,” said Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities. “But the market is trading like it’s more comfortable with the Fed coming to an endgame.”

Demand for longer-maturity Treasuries this week drove the yield on 10- and 30-year securities below the lower limit of the Fed’s overnight range. With relatively stable initial rates, this has led to an intensification of the steepest yield curve inversion in four decades – a widely watched indicator of potential economic difficulties ahead.

“The recession indicator narrative is strong, but from the Fed’s perspective, it’s part of the solution,” Faranello said.

The U.S. economy — and the labor market in particular — has so far proved quite resilient in the face of Fed rate hikes, which are aimed at curbing high and seemingly persistent inflation. Investors will therefore be watching closely for next Friday’s monthly jobs report for signs of cracking or indications as to whether it could pave the way for the Fed to change its policy stance.

They will carefully consider the words of Fed Chairman Jerome Powell and his colleagues, who will speak publicly next week for the last time before entering the usual blackout period before the Fed’s policy meeting. December 13 and 14. While the minutes of their last meeting showed that they were likely to slow the pace of tightening soon, officials were firm in reiterating the need for policy rates to rise above current levels.

At this point in the cycle, the Fed’s nervousness could prove less effective than the tone of the data, given expectations of a gradual slowdown in policy tightening from here amid a belief that the inflation has peaked and job creation is slowing.

The magnitude of the bond market’s long-term uptrend at the moment – and the depth of the yield curve inversion – means there could be some turbulence for Treasuries as traders navigate in a range of leading data over the coming week. , not just the jobs report. Recession bets could be helped by an expected contraction in the ISM manufacturing gauge, while the personal income and spending report will show how personal consumption spending, the Fed’s favorite inflation indicator, is doing. . Figures on the number of vacancies should also be published.

Current swap market prices show that the effective fed funds rate will rise to around 5% by the middle of next year, followed by a pullback that will push it down by more than half a percentage point. in early 2024. But some are betting on a much steeper reversal. , with trades this week related to futures on the guaranteed overnight funding rate focused on the possibility of a drop to 3% or even 2% by the end of 2023 or the beginning of 2024.

That said, there is resistance in some quarters to the current bond market consensus on the Fed, the economy and of course the possible return of low inflation next year. This week, Goldman Sachs Group Inc. said the 10-year will trade above 4% through 2024 as expectations of rate cuts next year are dashed by the economy not entering a recession. and inflation remaining high.

It’s far from central view though. Market prices suggest that while the Fed itself is not yet shifting policy, many investors are increasingly turning their eyes away from the risk of relentless Fed hikes and looking toward a possible economic downturn.

What to watch

  • Economic calendar:

    • November 28: Dallas Fed Manufacturing Activity Index

    • November 29: Conference Board Consumer Confidence; FHFA House Price Index

    • Nov. 30: ADP employment; MBA mortgage applications; third quarter gross domestic product; improve the trade balance of goods; wholesale and retail inventory; the MNI Chicago Purchasing Managers Index; pending home sales; JOLTS job vacancies; Beige Fed Book

    • 01 dec. : Personal report on income and expenses, including PCE; weekly jobless claims; ISM Manufacturing

    • December 02: Monthly Jobs Report

  • Fed calendar:

    • November 28: John Williams of the New York Fed; St. Louis Fed’s James Bullard

    • November 30: President Jerome Powell; Governors Lisa Cook and Michelle Bowman

    • 01 dec. : Vice President for Oversight Michael Barr; Dallas Fed’s Lorie Logan; Archer

    • December 02: Charles Evans of the Chicago Fed

  • Auction schedule:

    • November 28: 13 and 26 week invoices

    • November 29: 52-week bills

    • November 30: 17-week bills

    • December 1: 4-week and 8-week bills

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