Bond traders face week that threatens to shatter any market calm

Pedestrians in front of the Nasdaq MarketSite in New York. Traders in the world’s biggest bond market are bracing for another round of price swings driven by a Federal Reserve meeting, the Treasury Department’s quarterly debt-sales announcement and the continuing global economic uncertainty that’s fuelling large moves in the foreign-exchange market.

It’s been a volatile time for the Treasuries market – and the coming week will almost certainly be no exception. Traders in the world’s biggest bond market are bracing for another round of price swings driven by a Federal Reserve meeting, the Treasury Department’s quarterly debt-sales announcement and the continuing global economic uncertainty that’s fuelling large moves in the foreign-exchange market. The Fed is widely expected to raise its key rate by half a percentage point when it concludes its two-day meeting Wednesday, which would mark the biggest upward move since 2000. But traders will be closely watching Chair Jerome Powell’s press conference for more clues on just how high he thinks rates need to go to tamp down inflation. That will follow the Treasury Department’s quarterly refunding announcement the same day, which will detail the size of future bond auctions just as the Fed is preparing to pull support from the market by not buying new securities when some of its holdings mature. On Friday, the Labor Department will release its monthly jobs report – a crucial, market-moving gauge of the nation’s economic growth and the wage pressures fuelling inflation. The confluence threatens to make short-lived the modicum of stability that crept into the bond market during the past week, the first since late February during which yields didn’t jump to new highs. The ascendant US dollar, which tightens financial conditions and is a headwind to export growth, adds a fresh variable to the already complex calculus on whether Treasury yields have risen enough to cover the risks. “There are so many unknowns that I think the market will remain volatile until we get a clearer picture of how the economy holds up as the Fed actually hikes rates,” said Margaret Kerins, head of fixed-income strategy at BMO Capital Markets. “The range of outcomes is still too wide to rule out volatility for the market.” By late Friday, US two-year yields had risen about 5 basis points during the week to 2.71%. The yield has climbed nine months in a row, the longest stretch in Bloomberg data going back to 1976. Meanwhile, 10-year yields are hovering not far below the 2.98% level reached on April 20, which was the highest for the benchmark rate since December 2018. More volatility would add to the trying period for bondholders already facing one of the toughest markets in decades, with US Treasuries off to a loss of over 8% so far this year, according to a Bloomberg index. That puts the index on course for its worse year in history on the heels of a 2.3% decline in 2021. Bonds worldwide have been battered by the same rout as central banks worldwide seek to tamp down inflation. “I don’t think core bond investors are out the woods from high inflation yet,” said Jordan Jackson, global market strategist at JPMorgan Asset Management. Many dealers expect the Treasury on Wednesday to unveil a third but final quarterly round of cuts to longer-term debt sales, anticipating the Fed will set a date for the start of its quantitative tightening, or QT. Others think it’s possible auction sizes will remain stable for that reason. The Fed’s debt roll off, which will likely allow as much as $95bn of its debt holdings to mature each month without the proceeds being reinvested, will force the Treasury to borrow more from the public. That monthly cap would be divided between $60bn of Treasuries and $35bn of mortgage-debt, according to the minutes of the Fed’s last meeting. Adding to volatility is a battle between those who see growing risks of stagflation, or slowing growth coupled with sticky inflation, and others who expect the Fed to plough its policy rate up past neutral quickly and trigger a recession. The neutral rate is the level which neither restricts nor spurs economic growth. Deutsche Bank AG economists are in the forefront of firms flagging 2023 recession risk, predicting that the Fed may have to lift rates to as high as 6% to quell four-decade high inflation. Citigroup Inc sees the Fed lifting rates a half-point at each of its next four meetings but isn’t predicting a 2023 recession, even though it sees the risks of a downturn rising, according to Andrew Hollenhorst, the firm’s chief US economist. A record increase in employment costs in the first quarter, released on Friday, pushed money-market traders to ramp up the priced-in pace of 2022 tightening to about 2.5 percentage points from now until year’s end. A day earlier recession fears were briefly ginned by news that the US economy surprisingly shrank in the first quarter. “I struggle with the notion that the economy can handle continued hikes beyond neutral and QT,” said Priya Misra, global head of rates strategy at TD Securities. “I do think that the 10-year yield has some more room to rise as the flow effect of QT kicks in. But there is no consensus on either view in the market. People think that inflation could be sticky and that will not allow the Fed to slow down tightening, but I think the economy is not as resilient.”