Bond Traders on Edge Before Key Data as Flynn Spurs Shock Rally

Updated on
  • Jobs report could push 10-year back above crucial 2.4% level
  • Focus may return to fiscal and monetary policy for year-end
How Flynn's Guilty Plea Can Impact Markets, Policy

Within a span of minutes Friday, bond traders had to put on the back burner just about everything they were focused on heading into the home stretch of 2017.

Deliberations over how many times the Federal Reserve will tighten next year, and how many Republican senators were on board with the GOP tax plan suddenly seemed irrelevant for Treasuries. The benchmark 10-year yield plunged almost 10 basis points on news that former national security adviser Michael Flynn pleaded guilty to lying to federal agents and is cooperating with Special Counsel Robert Mueller.

[Click here for a Timeline of Michael Flynn’s Role in the Russia Probe]

“When the rules change, you put your hands in your pockets,” said Glen Capelo, head of rates at Academy Securities. “Between now and year-end it’s going to be very difficult to figure things out,” with Flynn’s plea adding to uncertainty surrounding the tax overhaul, the economic outlook and the Fed’s path.

Whether Friday’s Treasuries rally will be a one-day wonder will hinge on the days ahead. As soon as Monday, lawmakers may start the process of resolving the differences between the House and Senate tax bills, after the Senate passed its plan early Saturday morning.

Traders will also get a slew of crucial U.S. data, highlighted by November’s labor report, which is projected to show robust job growth. Confirmation of that expectation may push the 10-year yield to again test the key 2.4 percent technical level that some investors have called “the moment of truth” for bonds’ bull run. After all, it was above that mark just minutes before the Flynn news struck.

Should everything fall into place, it’ll have significant implications for the Treasury market. Bob Michele, who oversees about $483 billion as head of global fixed income, currency, and commodities at J.P. Morgan Asset Management, said Friday that the Fed could raise rates more than four times in 2018 if a tax overhaul becomes law.

Stimulative Properties

“It’s so stimulative for corporate America, it’s so stimulative for retail consumption,” he said in a Bloomberg Television interview.

The market is already shifting toward the Fed’s outlook, which calls for a December rate increase and then three more next year. Traders are getting closer to pricing in three rate hikes between now and year-end 2018, according to fed funds futures data. A month ago, they were barely factoring in two increases for that period.

Even with the market volatility around the Flynn news, the two-year yield, the coupon maturity that’s most sensitive to Fed policy, was the least affected, falling about 1 basis point. The 10-year note pared its advance, ending Friday at a 2.36 percent yield.

The moment of truth may still be ahead. But after Flynn’s plea, the day of reckoning has been pushed off.

What to Watch Next Week

  • The following economic indicators are scheduled for release:
    • Dec. 4: Factory orders; durable goods orders; capital goods orders
    • Dec. 5: Trade balance; Markit U.S. services and composite PMIs; ISM non-manufacturing composite
    • Dec. 6: MBA mortgage applications; ADP employment change; nonfarm productivity; unit labor costs
    • Dec. 7: Challenger job cuts year-over-year; initial jobless claims; continuing claims; Bloomberg consumer comfort; household change in net worth; consumer credit
    • Dec. 8: Change in nonfarm payrolls; unemployment rate; average hourly earnings; wholesale inventories; University of Michigan survey results
  • No Fed officials speaking during self-imposed blackout period before Dec. 12-13 FOMC meeting
    • Among the last pre-meeting remarks traders will have to digest, St. Louis Fed President James Bullard said Friday there was a “material risk of yield curve inversion” and it deserves attention from policy makers. Cleveland Fed President Loretta Mester on Thursday played down concerns about the yield curve
  • No Treasury coupon auctions, just bill sales on Dec. 4 and Dec. 5
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