Bond Traders Flatten Yield Curve Even as Inflation Set to BounceBy
Fed’s preferred inflation gauge may reach highest since March
Curve is narrowest in a decade as more rate hikes seen
The bond market is showing little fear of the inflation bogeyman, even before a report that’s projected to show a key measure of price growth climbing.
That’s the signal from the Treasuries yield curve, which from five to 30 years is the flattest since October 2007. The yield spread between these maturities touched 52 basis points last week after Federal Reserve Chair Janet Yellen downplayed the significance of the relentless trend. She said the curve “could more easily invert” nowadays with the term premium for longer-dated bonds so negative.
At first glance, one might see the inflation data out this week as giving pause to those in the year’s dominant fixed-income bet. After all, inflation is the bane of longer maturities. The Fed’s preferred gauge of price growth, set for release Friday, is expected to jump to 1.8 percent year-over-year, the highest since March. But inflation expectations are so solidly anchored below the Fed’s 2 percent goal that bond traders see little cause for alarm.
“The only trade to have on in the marketplace is the yield-curve flattener,” said Tom di Galoma, managing director of government trading and strategy at Seaport Global Holdings. “There’s no reason for the curve to steepen -- we haven’t seen inflation in so long.”
Even if it’s just one month of data, bond traders can’t take their eye off the ball. They need to nail their inflation call to get 2018 right. While policy makers project three rate increases in 2018, the market is still reluctant to price in two.
In her final scheduled post-meeting press conference last week, Yellen reiterated the Fed’s view that low inflation was largely due to transitory effects. With the unemployment rate the lowest since 2000, officials expect wage growth to pick up.
Jefferies LLC sees higher wages and the presumed enactment of tax-overhaul legislation spurring the Fed to hike four times in 2018. It joins firms including Goldman Sachs Group Inc. and JPMorgan Chase & Co. in forecasting more tightening next year than the Fed itself.
While a faster pace of rate increases could lead to even further curve flattening, the tax debate in Washington remains a wild card. Congressional leaders still need a floor vote on the legislation, not to mention a resolution to avoid a government shutdown at the end of the week.
In other words, the year isn’t over quite yet, even if traders are ready to look past the inflation data and focus on Friday’s abbreviated work-day.
What to Watch This Week
- U.S. politics in focus, with tax legislation in the home stretch and a potential government shutdown looming
- The following economic indicators are scheduled for release:
- Dec. 18: NAHB housing market index
- Dec. 19: Housing starts; building permits; current account balance
- Dec. 20: MBA mortgage applications; existing home sales
- Dec. 21: GDP annualized QoQ; initial jobless claims; personal consumption; core PCE QoQ; Philadelphia Fed index; FHFA house price index; Bloomberg consumer comfort and economic expectations; leading index
- Dec. 22: PCE deflator and core PCE; personal income and spending; durable and capital goods orders; new home sales; University of Michigan survey data; Kansas City Fed manufacturing
- No Fed speakers scheduled after last week’s rate hike
- Treasury’s only auction aside from bills comes Dec. 21, when it sells $14 billion of five-year Treasury Inflation Protected Securities
- Sifma recommends an early bond-market close of 2 p.m. ET on Dec. 22, ahead of the Christmas Day holiday Dec. 25
— With assistance by Jacob Bourne