In the blink of an eye on Tuesday, the US bond market’s focus shifted back to fears of an unexpectedly sharp economic slowdown and away from persistently high inflation for most of the trading day.
That shift in sentiment came after data showed new US home sales fell in July to the lowest level in more than six years. Gauges of the manufacturing and services sectors were also below expectations, reinforcing similar weakness seen in the eurozone. For most of Tuesday, traders priced in a higher chance of a 50 basis point rate hike by Federal Reserve policymakers in September, which would raise the Fed Funds rate target to between 2.75% and 3% — pulling back from Monday’s expectations for a bigger 75 basis point increase next month. But after the dust settled, fed fund futures traders were again on the fence, pricing in about a 50-50 chance of either a 50- or 75-basis-point increase. By the end of the day, those odds shifted to around 48%-52% in favor of the bigger move.
Financial markets are caught between two narratives — one about alarmingly high inflation forcing policymakers to continue aggressively raising borrowing costs, the other about an economic slowdown solving the inflation problem and prompting the Fed to pivot . Both of these narratives could anyway add up to what looks and sounds like the worst of all worlds: stagflation.
“The data is weakening and the market is looking at the possibility of a Fed pivot” in the form of a half-point hike in September, said trader Tom di Galoma of Seaport Global Holdings in Greenwich, Connecticut. “I don’t see a pivot, but the market is starting to see.”
“We’re starting to go into a real slowdown in the housing market, which overall is not good for the economy just because that market is fueling so much of the spending that was going on,” he said by phone Tuesday. “But my impression is that the Fed will want to get rates as high as they can before a full-blown slowdown takes place around October. The Fed was going to go ahead with a slowing economy anyway, but when the numbers get real, people get nervous.”
On Tuesday, US yields initially fell broadly after a disappointing July new home sales report, led by 2-year TMUBMUSD02Y,
which captures the expected path of the Fed’s interest rate policy. The 10-year yield TMUBMUSD10Y,
fell below 3% during morning New York and its 2-year spread narrowed to minus 24 basis points, in a worrisome sign of the outlook ahead of Fed Chairman Jerome Powell’s speech at the central bank’s conference on Friday in Jackson Hole. , Wyo.
However, by the end of the US trading day, the morning selloff in Treasurys had subsided, leaving 7-30 year yields slightly higher.
Meanwhile, US stocks struggled to recover on Tuesday, a day after posting their worst day since June, on fears the Fed will move sharply higher interest rates. The Dow industrials DJIA ended down 154 points, or 0.5%, while the S&P 500 SPX closed 0.2% lower and the Nasdaq Composite COMP was little changed. Meanwhile, the ICE US Dollar Index DXY fell 0.5%, retracing much of Monday’s gain.
“There’s a lot of uncertainty out there and the narrative seems to change week to week and sometimes day to day,” said chief trader John Farawell with Roosevelt & Cross, a bond underwriter in New York. “New house sales data appeared to turn things around, with a firmer Treasury market before sentiment returned to neutral.”
“People aren’t really sure what’s going on,” Farawell said by phone.
For Jay Hatfield, chief investment officer at Infrastructure Capital Advisors in New York, which oversees about $1.18 billion in assets, the “real story” behind Tuesday’s moves in the bond market is that “US Treasuries outperformed of the rest of the world”.
The reason the U.S. bond market had sold off on Friday was because the global bond market “took a crack,” according to Hatfield. Printed Germany a 5.3% month-on-month gain in producer prices and an “unthinkable” year-on-year gain of more than 30%, while gas prices in some parts of Europe have reached the energy equivalent of $500 a barrel. fears that the European Central Bank will be “more aggressive”.
But as of Tuesday, a level of 3% in the U.S. 10-year yield found interest from both buyers and sellers and remained “fairly stable,” Hatfield said by telephone, adding that he expects the Fed to raise rates by 50 basis. points in September.
“You can’t look at US interest rates in a vacuum and US bonds are by far the most attractive in the world,” he said. Meanwhile, a short-term bond yield trading above longer-term rates “prices in stagflation.”