(Oct 24): Data-starved bond traders risk seeing the October rally in Treasuries spoiled by the key inflation figures they’ve been waiting for.
US government securities rallied for much of October, sending benchmark 10-year yields below 4% to their lowest levels since April, even as a government shutdown delayed the release of crucial official statistics that would normally help traders plot the likely path of the economy and monetary policy.
Now, September inflation figures that were originally scheduled for Oct 15 are set to be released Friday, just days before the US Federal Reserve next meets. And while most investors see little chance of the consumer price data shaking expectations for a quarter-point interest-rate cut on Oct 29, a surprise on the upside has the potential to upend the consensus for multiple reductions in the months ahead, putting recent market gains in jeopardy.
“There’s a risk that a higher-than-expected figure could change the outlook,” said Kathy Jones, chief fixed income strategist at Charles Schwab. “It could prove to be a tipping point for the market.”
Through Wednesday, Treasuries returned 1.3% in October, on track for the best monthly performance since February, according to a Bloomberg index. Multiple drivers fuelled the gains, from the potential for the shutdown to dent growth to resurgent trade tensions between the US and China, as well as several high-profile bankruptcies and a narrowed federal budget deficit.
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Inflation, however, has continued to exceed the Fed’s 2% target. And while that didn’t keep the Fed from cutting rates last month, some officials have expressed the view that stubborn inflation merits a cautious approach to further reductions.
Economists expect the September consumer price report will show increases of 0.4% overall, and 0.3% excluding food and energy. The estimated year-on-year rates are 3.1% for both gauges. For the overall measure, that would be the highest since May 2024.
“Inflation has been sticky,” said Tony Farren, managing director in rates sales and trading at Mischler Financial Group. While a strong number would likely trigger a negative reaction, a softer number might not result in gains, as traders would likely be skeptical of it, he said. “They’ll say, ‘There’s a lot of guess-timates in that number,’” Farren said.
Another wrinkle is oil. Until this week, expectations for future inflation generally had been in decline, thanks in part to a drop in crude that helped send the price of retail gasoline — which accounts for about 3% of the consumer price index (CPI) — to the lowest level since December. That trend hit a snag on Thursday, however, when crude oil surged as much as 6.3% after the US imposed sanctions on Russian producers.
Short-term interest-rate futures markets are currently pricing in a high likelihood of quarter-point rate cuts at the subsequent Fed meeting in December, and at least three more next year. Those expectations are vulnerable if inflation flares up. Fed policymakers including Dallas Fed president Lorie Logan, governor Michael Barr and St Louis Fed president Alberto Musalem in recent weeks have said the potential for tariffs to increase price pressures has made them hesitant about additional rate cuts despite slowing job growth.
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What Bloomberg strategists say ...
“Bonds and equities face asymmetric downside risks should inflation come in hotter-than-expected on Friday. However, if traders start questioning the quality of the data, the first reaction may not be the last.” —Tatiana Darie, Macro Strategist, Markets Live.
“If the economy doesn’t continue to decelerate and the inflation numbers stay substantially above target, it’s going to be hard to make a case to meet the market’s expectations” for a full percentage point of rate cuts in the next year, said Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income. “Now that this has been fully priced in, there’s perhaps some anxiety about where exactly these inflation numbers are, and whether they’re supportive of the narrative that’s been priced in.”
Investor anxiety on that point is reflected in Treasury options activity, which has included several notable trades for protection against a rebound in the 10-year note’s yield beyond 4.05% by the end of the week. The benchmark closed at 4% on Thursday after the spike in oil, up 0.05 percentage point on the day, and was little-changed in early Asian trading on Friday.
Interest-rate strategists at Barclays Capital this week recommended exiting a bullish position in Treasuries, recommended since June, based in part on the potential for the September CPI data to erode profit in it.
And those at Morgan Stanley, citing “risk of an upside surprise” by the September CPI based on seasonal patterns, advised positioning for an increase in 10-year breakeven inflation rates — the CPI rate needed to equalise the returns of regular and Treasury inflation-protected securities, or TIPS.
“We are a little more concerned about inflation than the market is here,” said Anders Persson, CIO and head of global PHI at Nuveen Asset Management. “We are still of the view the Fed moves at the next meeting and the rate path is lower, but we want to get more insight on inflation.”
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