Bond bulls yesterday were looking to the US Federal Reserve’s decision for vindication as US Treasuries head for their best month in a year.
The Fed was set to release yesterday its first policy statement since it raised interest rates from near zero last month.
After this month’s 1.9 percent rally in Treasuries, bond bulls are watching for signs that officials expect this year’s oil price plunge to dampen inflation, or any mention of tightening financial conditions resulting from tumult in global stocks and higher-yielding debt.
Traders are banking on a repeat of September last year, when the US central bank said “global economic and financial developments may restrain economic activity somewhat” after a surprise devaluation of the Chinese currency roiled global markets.
The Fed stood pat in September last year, and Wall Street anticipated the same result yesterday.
“Any reference to the volatility we’ve seen in the global financial markets, and the possible slowdown in Asia, is what the market’s going to be looking for,” said Gary Pollack, who manages US$12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “That’ll be key.”
It would be tough for traders to bet on an even slower pace of Fed increases, Pollack said.
Futures prices show traders consider it a foregone conclusion that officials will back off the median projection for rates that they released last month. That forecast called for four increases this year, assuming they come in quarter-point steps.
The benchmark 10-year Treasury yield was little changed at 1.99 percent as of 6:41am in London yesterday, according to Bloomberg Bond Trader data. The price of the 2.25 percent security due in November 2025 was 102 9/32.
Even before this month’s market turmoil, fed funds futures were pricing in just two rate increases by the end of the year.
That has shrunk to about one, and traders see a one-in-four chance the Fed will raise rates at its meeting in March, data compiled by Bloomberg show.
Traders are also discounting any possibility of an unexpected jump in inflation or a surprise Fed decision on interest rates. The 10-year term premium, or the extra compensation investors demand for such risks over the next decade, has been negative all year and is close to the lowest since April last year, according to a Fed Bank of New York model.
“The belief is that international issues will prevent the Fed from doing the four rate hikes indicated” last month, said John Briggs, head of strategy for the Americas in Stamford, Connecticut, at RBS Securities Inc, one of the 22 primary dealers that trade with the Fed.
Officials “are probably going to do as little as they can, so they don’t contribute to volatility in the market,” he said.
Financial conditions have tightened during this year’s market volatility, the Bloomberg US Financial Conditions Index shows.
The gauge is around minus-0.3, with a negative reading indicating conditions have deteriorated relative to normal levels from before the financial crisis. It is still above the minus-1.1 reading from August last year.
This month’s tumble in oil prices to a 12-year low calls into question the Fed’s assertions that consumer price growth is on its way back to officials’ 2 percent target. The Fed’s preferred gauge of inflation has not reached that level since 2012.
As energy prices fell, a gauge of bond-market inflation expectations dipped as well. The 10-year break-even inflation — or the difference between yields on 10-year notes and inflation-linked debt — fell to its lowest since 2009 this month.
Pollack said he was bullish on longer-maturity Treasuries relative to shorter-term securities, because he expects inflation to remain tame.
Even so, he said Treasuries may not reap any benefit if the Fed does include a reference to global financial conditions posing a risk for growth.
By signaling fewer rate increases, that may boost stocks, luring money away from US debt, he said.
“You could see equity markets rally on that news and fixed-income markets” decline, he said.
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