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Bond Traders Step Back From 3% to Watch Powell Navigate Fedspeak

  • This week brings Congressional testimony from new Fed chairman
  • Goldman Sachs predicts faster rate-hike path, 10-year to 3.25%
CBA’s Stephen Halmarick discusses how Fed’s Powell will approach rates and where 10-year bond yields may peak.

Bond traders came the closest in four years to a 3 percent yield on the 10-year Treasury note. Whether it breaches that level may be determined by how new Federal Reserve Chairman Jerome Powell handles the limelight.

Powell, who took over from Janet Yellen this month, will speak before the House Financial Services Committee on Tuesday and the Senate Banking Committee two days later, in what’s known as the Humphrey-Hawkins testimony. It’ll be the first time since Powell was sworn in that bond traders get a chance to parse every word from the new Fed leader, as they did with his predecessors.

Now, a fair amount is scripted -- the Fed released its Monetary Policy Report on Feb. 23 -- and as a former member of the central bank’s board of governors, Powell has had years to hone the craft of Fedspeak that’s largely kept volatility at bay. He has also long been viewed by some as Yellen 2.0. TD Securities strategists “expect nothing new,” while the BMO Capital Markets simply says “yawn.”

But with an economy that the Fed says may already be beyond full employment, inflation showing signs of life, and fiscal stimulus on top of that, it may be a struggle for Powell to tamp down the optimism when in the Congressional hot seat.

“He’s going to try to emphasize continuity, gradualism, but I think it’s going to be hard for him not to sound a little bit hawkish, given the backdrop both in terms of inflation and in terms of growth,” David Riley, head of credit strategy at BlueBay Asset Management, said in an interview on Bloomberg Television.

Some strategists are already bracing for a more aggressive Fed and for further bond-market losses ahead, even though the benchmark 10-year Treasury yield fell on a weekly basis for the first time all year. One-time month-end flows and re-balancing may have contributed to the market’s rebound in the latter part of last week, which sent the 10-year yield to 2.87 percent. It reached a four-year high of 2.9537 percent on Wednesday after the Fed released minutes of its most recent policy meeting.

Treasury yields have climbed so quickly so far this year that some analysts are already reviewing their projections for the year. Bank of America Corp. last week raised its 10-year U.S. yield forecast for year-end to 3.25 percent, from 2.9 percent. Goldman Sachs Group Inc. boosted its estimate for the end of 2018 to the same level. 

Goldman Sachs Chief Economist Jan Hatzius suggested the Fed could pick up the pace of tightening if inflation reaches policy makers’ target and the unemployment rate grinds lower. Five rate increases this year is a “low probability,” but the bank sees four in 2018 and another four in 2019. As of now, Fed policy makers only anticipate moving three times this year and two to three times next year.

If Powell hints that he and the Federal Open Market Committee are moving toward a more hawkish path, it would be a “bearish shock” that would roil five-year Treasury notes in particular, according to BMO.

“He has to be really careful about over-hiking late in the cycle here as the enthusiasm continues to go up,” said Michael Collins, senior investment officer at PGIM Fixed Income, which oversees more than $700 billion.

Bond traders know Yellen was painstakingly measured in her words. They’ll soon find out just how much continuity Powell brings in live testimony.

What to Watch This Week

  • After a quiet week for U.S. economic indicators, data releases will ramp up, with the Fed’s preferred inflation gauge among the highlights
    • Feb. 26: Chicago Fed national activity index; new home sales; Dallas Fed manufacturing activity
    • Feb. 27: Advance goods trade balance; wholesale and retail inventories; durable and capital goods orders; house price purchase index; S&P CoreLogic Case-Shiller home price indexes; Richmond Fed manufacturing index; Conference Board consumer confidence survey data
    • Feb. 28: MBA mortgage applications; second reading of GDP, personal consumption and core PCE for the fourth quarter; MNI Chicago Business Barometer; pending home sales
    • March 1: Personal income and spending, PCE deflator and core PCE for January; initial and continuing jobless claims; Bloomberg weekly consumer comfort index; Markit U.S. manufacturing PMI; construction spending; ISM manufacturing, employment, prices paid and new orders; Wards vehicle sales
    • March 2: University of Michigan survey data
  • Powell’s testimony to Congress on Feb. 27 and March 1 is the main event among Fed speakers
    • On Feb. 26, Fed Governor Randal Quarles and St. Louis Fed President James Bullard speak on U.S. economy
  • No auctions of coupon-bearing Treasuries this week, only bills 
    • The $51 billion three-month bill sale and the $45 billion six-month offering scheduled for Feb. 26 both match record high volumes set last week
    • The Treasury will also auction 52-week bills and four-week bills on Feb. 27
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