Jerome Powell arrives for a dinner during the Kansas City Federal Reserve’s Jackson Hole Economic Policy Symposium in Moran, Wyoming, on Aug. 21.
(Bloomberg) — Jerome Powell sent the US bond market up on Friday by telegraphing his Federal Reserve will resume reducing interest rates as soon as next month.
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Beyond September, it’s up to the economy how much further he cuts — and how much more Treasuries can rally.
The central bank chief on Friday delivered his strongest signal yet that he’s ready to end an eight-month pause, saying the downside risks to the labor market may “warrant adjusting our policy stance.” Treasury bonds jumped, widening the gap between short- and long-term yields to the most in almost four years — a typical reaction to a more dovish Fed.
Yet for all the sense of the relief, there are some lingering doubts about how much rates will come down. Futures traders don’t see a quarter-point cut at its Sept. 17 interest-rate decision as a sure thing, pricing in the odds at around 80%. And even with Friday’s gains, bond yields still haven’t pushed below lows from earlier this month as investors wait for employment and inflation data that come in before the next meeting.
The restrained response reflects the vexing cross-currents that are facing the Fed, which is balancing a softening labor market against the risk that inflation will rise from still elevated levels as President Donald Trump’s tariffs ripple through the economy.
A case in point: This week, the Fed’s favored inflation gauge may show price pressures remain strong. The auctions of two-，five- and seven-year notes will test investors’ demand. And even with Powell’s pivot, there’s the possibility of a repeat of last year, when the Fed started easing policy, only to stop in January when the economy kept exhibiting surprising strength.
Powell “solidifies market expectations of a cut in September,” but “it’s less about whether the move comes in September or October,” said Gregory Peters, co-chief investment officer at PGIM Fixed Income. “We don’t know what the next six months will look like. It’s still going to be an environment of mixed data, keeping the bond market on edge.”
The policy-sensitive two-year yield rose one basis point to 3.71% on Monday after tumbling 10 basis points Friday to approach its early August low – which was set after the employment report showed job growth was far weaker than expected. Interest-rate swaps showed traders started pricing in two quarter-point reductions by year-end, with a small chance given to a third such move.
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The market expectation of easing “is the appropriate reaction,” said John Briggs, head of US rates strategy at Natixis North America. But, he added, “anything further than two-and-a-half cuts being priced before we get to payrolls is too aggressive.”
Powell’s pivot has given momentum to the so-called curve steepening trade, a position that wagers short-term rates will fall the fastest as easier monetary policy promises to increase the pace of growth. On Monday, the yield difference between the five- and 30-year bonds reached the highest since 2021.
What Bloomberg strategists say…
“The door is open for a rate cut in September, although it is not yet a guarantee, and the medium-term stance is skewed in a less dovish direction than was the case five years ago.”
— Cameron Crise, Macro Strategist, Markets Live.
For the full analysis, click here
Bond investors remain comfortable owning shorter maturities that have scope to rally once the Fed resumes easing. But they’ve largely been less willing to hold longer-dated Treasuries, which are susceptible to future inflation and the risks posed by the swelling government deficit.
The trade has also been seen as a hedge against the unprecedented pressure that Trump has put on the central bank to lower borrowing costs. He has repeatedly criticized Powell and on Friday threatened to fire Governor Lisa Cook over allegations of mortgage fraud. Cook said she won’t be bullied into resigning.
The president’s attacks on the Fed’s independence have raised concerns in markets, given that excessive rate cuts could fan inflation and erode the long-term value of fixed-income securities.
“The front end now has Chair Powell on its side, and yields there should stay down,” said Padhraic Garvey, head of research for the Americas at ING. “The long end is not loving this,” adding it “likely reflects a suspicion that the Fed could be taking risks with inflation here.”
The market movements also reflect the possibility that cutting rates while inflation is sticky — and may rise further — threatens to limit how much yields will fall on bonds due in 10 years or longer. There’s also the chance of a repeat of late 2024, when longer yields rose even as the Fed cut rates by a full percentage point.
On Friday, market measures of inflation expectations edged up.
“If we do have a Fed that’s cutting in this environment where inflation is still a far cry from their target, we think the market should show more signs of this inflation target moving higher and becoming unanchored,” said Meghan Swiber, an interest rate strategist at Bank of America Corp. on Bloomberg Television.
The bottom line for bullish bond investors is that they remain at the mercy of another potential selloff if the economic or inflation data is surprisingly strong.
“There’s a long way between now and September 17th,” said Michael Arone, chief investment strategist at State Street Investment Management.
What to Watch
Economic data:
Aug. 25: Chicago Fed national activity index; new home sales; building permits; Dallas Fed manufacturing activity
Aug. 26: Philadelphia Fed non-manufacturing activity; durable and capital goods orders; FHFA house price index; S&P CoreLogic 20-city and US HPI; Richmond Fed manufacturing index and business conditions; Conference Board consumer confidence; Dallas Fed services activity
Aug. 27: MBA mortgage applications
Aug. 28: Initial jobless claims; GDP annualized QoQ; GDP price index; personal consumption; pending home sales; Kansas City Fed manufacturing index
Aug. 29: Bloomberg US economic survey (Aug); personal income and spending; PCE price index; advance goods trade balance and imports and exports; wholesale and retail inventories; MNI Chicago PMI; U. of Michigan sentiment and inflation expectations; Kansas City Fed services activity
Fed calendar:
Aug. 25: Dallas Fed President Lorie Logan; New York Fed President John Williams
Aug. 26: Richmond Fed President Thomas Barkin
Aug. 27: Barkin
Aug. 28: Governor Christopher Waller
Auction calendar:
Aug. 25: 13-, 26-week bills
Aug. 26: 6-week bills; 2-year notes
Aug. 27: 17-week bills; 2-year floating rate notes; 5-year notes
