Investors Brace for Risk Inflation Dooms Bonds to Bear Market
(Bloomberg) — Investors are bracing for key inflation data next week that could worsen the bond-market rout.
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January consumer prices are seen accelerating for the first time in three months, even as the annual inflation rate declines further, a Labor Department report Tuesday is expected to show.
The reversal would come on the heels of blowout January jobs data that sent bonds tumbling since then. Afterward, Federal Reserve officials conveyed that the inflation battle is not over and it may take a lot longer for the central bank to achieve price stability. It would also dash hopes that inflation would remain in a downward trend, a view that sparked a rally in Treasuries last month.
“There is a near-term risk that inflation does not fall as rapidly as the market is expecting,” said Jimmy Chang, chief investment officer of Rockefeller Global Family Office.
With some up-tick in CPI anticipated, the danger remains that a larger rise in monthly measures would extend the selloff in Treasuries. Swaps traders have hoisted their outlook for the terminal funds rate to nearly 5.20%, slightly above the median forecast set by Fed officials at their December meeting.
That compares to earlier in the month when bets showed the Fed would fail to get its policy rate even to 5%. Upping the ante, interest rate option activity this week has been spurred by traders betting on the central bank pushing beyond a peak forecast of 5% to 5.25% this year they made in December, to as high as 6%.
The pressure on central banks globally was underscored last week in Australia and Mexico, where stubborn inflation pressure sparked hawkish rate hikes and policy guidance.
Fed Chair Jerome Powell also struck a wary tone, telling an audience in Washington this week: “If we continue to get, for example, strong labor market reports or higher inflation reports, it may well be the case that we have do more and raise rates more than is priced in.” During another speech, Governor Christopher Waller said: “I am prepared for a longer fight to get inflation down to our target.”
That kept the pressure on Treasuries, with the two-year yield climbing above 4.5%, its highest level since late November and up from last week’s low of 4.03%. The benchmark also rose some 0.86% above the 10-year yield, marking the deepest curve inversion seen for the cycle. It shows how the prospect of a more aggressive Fed path is expected to eventually stall the economy and bring inflation down, rewarding holders of longer-dated Treasuries.
“If people fail to see a continual improvement in CPI then jobs matter even more,” said Michael Kelly, global head of multi-asset at PineBridge Investments. “CPI still does matter. And we have gasoline ticking up, used cars ticking up and technical adjustments.”
Kelly said a firming “global economy and the recent US payrolls data means overall it’s very hard right now for the long end to make any more meaningful decline in yields.”
Barclays US economist Pooja Sriram and her colleagues project that US core inflation accelerated last month amid a still robust service sector and as goods inflation rebounded. On Friday, they raised their Fed funds forecast — seeing the terminal rate landing in a 5.25%-5.5% range. The Fed’s current range is 4.5%-4.75%.
Barclays Changes Fed Forecast, Sees 25bp Rate Hikes Through June
On Friday, the University of Michigan’s survey-based measures showed price expectations over the coming year rose to 4.2% from 3.9% but remained well below levels seen in the first half of last year. Powell and other Fed officials have stressed many times over the past year the importance of inflation expectations remaining anchored — as consumers seeing higher prices down the road risks driving actual inflation levels upward.
Even in a case where CPI behaves a little better, the prospect of more persistent inflation pressures can not be ruled out given tight labor conditions that are seen sustaining firm wage growth.
“Sources of inflation come from shortages such as we are seeing in labor at the moment,” and “wages will continue to grow,” said Matt Smith, investment director at London-based Ruffer LLP. Expectations embedded in the yields of five- and 10-year Treasury inflation-protected securities rose to their highest levels since early December this week. Smith said Ruffer is positioned for higher long-dated breakevens because they expect the Fed is unable to ultimately reduce inflation down to its price stability target of 2%.
In addition to CPI data, a host of Fed officials are scheduled to speak in the upcoming week, including Fed Governor Michelle Bowman and New York Fed President John Williams.
What to Watch
Economic data calendar
Feb. 14: NFIB small business optimism; consumer price index; real average hourly earnings
Feb. 15: MBA mortgage applications; retail sales; industrial production; capacity utilization; business inventories; NAHB housing index; TIC flows
Feb. 16: Producer price index; jobless claims; building permits; housing starts; New York Fed services business activity
Feb. 17: Import and export price index; leading index
Federal Reserve calendar
Feb. 13: Fed Governor Michelle Bowman
Feb. 14: Dallas Fed President Lorie Logan; Philadelphia Fed President Patrick Harker; New York Fed President John Williams
Feb. 16: Cleveland Fed President Loretta Mester; St Louis Fed President James Bullard; Fed Governor Lisa Cook
Feb. 17: Richmond Fed President Thomas Barkin; Bowman
Feb. 13: 13- and 26-week bills
Feb. 14: 12-day CMB
Feb. 15: 17-week bills; 20-year bonds
Feb. 16: 4-and 8-week bills, 30-year TIPS
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