Bond Traders Are Desperate for Direction From Yellen in Jackson Hole

Reasons Not to Expect a Huge Policy Unveiling From Yellen
  • Communication falls short amid mixed messages: Pimco’s Clarida
  • Yield swings diminish as investors take to sidelines

The world’s biggest bond traders are getting fed up with Fedspeak.

Weeks of conflicting economic reports have whipsawed investors seeking to handicap the path of interest rates, and money managers overseeing about $6 trillion, including Pacific Investment Management Co. and Vanguard Group Inc., say policy makers aren’t making their task any easier.

QuickTake The Fed Lifts Off

While the minutes from the Federal Reserve’s July meeting showed divisions within the rate-setting committee, New York Fed President William Dudley, San Francisco Fed President John Williams and Kansas City Fed President Esther George have signaled that a hike may be coming by year-end. Amid the mixed messages, investors are taking to the sidelines, leaving benchmark 10-year yields stuck in their narrowest range in a decade.

The $13.5 trillion Treasuries market is like a coiled spring, leaving the Masters of the Universe -- a phrase Tom Wolfe used in his novel “Bonfire of the Vanities” to describe Wall Street bond traders -- desperate for direction as Fed Chair Janet Yellen takes the stage Aug. 26 in Jackson Hole, Wyoming. Fund managers are looking for her to weigh in on the prospects for economic growth and inflation, potentially allowing them to coalesce around a likely path for rates in 2016. With the right trigger -- such as a nod at September as “live” -- she has the potential to generate the wildest market gyrations in weeks.

“Markets are eagerly awaiting some clarity,” said Brian Smedley, the Santa Monica, California-based head of macroeconomic and investment research at Guggenheim Partners, which manages $240 billion. Investors “are a little bit tired, a little bit struggling to know how to weigh the many views that are being shared and the debates that are going on in public.”

For a preview of the Jackson Hole meeting, click here.

Some of the fatigue results from months of remarks by officials indicating higher rates were ahead. In late May, Yellen sent the bond market tumbling when she suggested in a Harvard University appearance that a rate increase in the following months might be appropriate. That prospect crumbled a week later when May labor data showed the smallest job gains in almost six years. In June, she sketched a cautious view of the economy in testimony before lawmakers in Washington.

Two-year notes, the coupon maturity most sensitive to Fed policy expectations, yielded 0.77 percent as of 9:45 a.m. in New York, down from about 0.9 percent three months ago.

The market-implied probability of a rate increase by year-end is below 60 percent, and traders see roughly a 30 percent chance of a hike when the Fed releases its next decision, on Sept. 21, futures show.

‘Lost Credibility’

Hawkish comments this month have failed to jolt the bond market out of its doldrums.

“The Fed has lost credibility, because it’s trying to talk the markets into the traditional stance that you need to not be so complacent,” said Tim Hopper, chief economist at TIAA, which manages $889 billion. “But it hasn’t really voted in that direction, and actions speak louder than words.”

The New York Fed’s Dudley said Aug. 16 that a September hike was possible, and the San Francisco Fed’s Williams echoed that sentiment. The Kansas City Fed’s George said in a Bloomberg Television interview broadcast Thursday that the labor market nearing full employment and inflation rising toward the central bank’s target should prompt higher rates.

Yet the rhetoric marks a contrast with the minutes of the July Fed meeting, released Aug. 17, which showed members were divided on whether a rate increase was appropriate in the near future.

Chair’s Challenge

“There’s a failure to communicate,” Richard Clarida, global strategic adviser at Newport Beach, California-based Pimco, which manages $1.51 trillion, said on Bloomberg Television on Aug. 19. “The chair has not come forward to convey where she wants to take the committee, so as a result we have a mixed message.’’

Though officials have left investors “confused,” the central bank may be satisfied with how the market is pricing in the path for rates this year, Michael Buchanan, deputy chief investment officer at Western Asset Management, said on Bloomberg Television this week.

“They are going to be very thoughtful with that first hike in 2016,” said Buchanan, whose firm manages about $460 billion. “We think they are going to pass in September.”

The risk to traders is that after shrugging off hawkish statements, they’ll be caught flat-footed by a move toward higher rates, especially as declining volatility suggests they aren’t inclined to prepare for a policy change anytime soon.

That’s why investors are looking for Yellen to bridge the gap between a market that sees little scope for steeper borrowing costs, and the Fed’s projection of steady rate increases for years to come.

If the Fed chair signals one hike is ahead in 2016, while indicating a dovish outlook longer-term, investors plan to buy 10-year notes and sell two-year debt, according to a client survey by Steven Englander, global head of Group-of-10 currency strategy at Citigroup Inc. in New York.

“The market is looking for some clarity on the path for rates over the medium-term, as opposed to meeting-to-meeting guesswork,” said Roger Aliaga-Diaz, senior economist in the investment strategy group at Vanguard, which manages more than $3 trillion.

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