In the blink of an eye on Tuesday, the U.S. bond market’s focus shifted to fears of a sharp and unexpected economic slowdown and away from persistently high inflation for most of the day. negotiation.
This shift in sentiment came after data showed the U.S. new home sales plunged in July to its lowest level in more than six years. Gauges of the manufacturing and service sectors also fell below expectations, reinforcing a similar weakness seen in the euro area. For much of Tuesday, traders priced in a better than unlikely chance of a 50 basis point interest rate hike by Federal Reserve policymakers in September, which would lift the target federal funds rate between 2.75% and 3% – pulling back from Monday’s expectations for a bigger hike of 75 basis points next month. But once the dust settled, fed funds futures traders were once again on the fence, pricing in about a 50 to 50 chance of a 50 or 75 basis point rise. By the end of the day, those odds had risen to around 48% to 52% in favor of a bigger move.
Financial markets have been caught between two stories – one of worrying inflation that forces policymakers to continue to aggressively raise borrowing costs, the other of an economic slowdown that solves the problem of inflation and prompts the Fed to pivot. Either way, these two stories could add up to something that looks and feels like the worst of all worlds: stagflation.
“The data is weakening and the market is eyeing a Fed pivot” in the form of a September half-point hike, 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 one.”
“We’re starting to get into a real downturn in the housing market, which overall isn’t good for the economy just because that market is driving a lot of the spending going on,” he said. by phone on Tuesday. “But I have a feeling the Fed will want to get rates as high as possible before a full downturn takes place around October. The Fed was going to get into a slowing economy anyway, but when the numbers become real, people get nervous.
On Tuesday, U.S. yields first fell across the board after the disappointing July new home sales report, led by the 2-year
which reflects the expected path of the Fed’s rate policy. 10-year yield
fell below 3% during the New York morning, and its 2-year spread narrowed to minus 24 basis points in a still worrisome sign of the outlook ahead of the Fed Chairman’s Friday speech, Jerome Powell, at the central bank symposium in Jackson Hole, Wyo.
But towards the end of the U.S. trading day, Tuesday morning’s Treasury sell-off had eased, leaving 7-30-year yields slightly higher.
Meanwhile, U.S. stocks struggled to regain their footing on Tuesday, a day after posting their worst day since june for fear that the Fed will go ahead with significantly higher interest rates. Dow Industrials DJIA ended down 154 points, or 0.5%, while the S&P 500 SPX ended down 0.2% and the Nasdaq Composite COMP has changed little. Meanwhile, the ICE US Dollar Index DXY was down 0.5%, retracing much of Monday’s advance.
“There’s a lot of uncertainty out there and the narrative seems to be changing week to week and sometimes day to day,” said chief trader John Farawell at Roosevelt & Cross, a bond underwriter in New York. “The new home sales data seemed to turn things around, with a firmer Treasury market, before sentiment turned neutral again.”
“People aren’t really confident with what’s going on,” Farawell said by phone.
For Jay Hatfield, chief investment officer of Infrastructure Capital Advisors in New York, which oversees about $1.18 billion in assets, the “real story” behind Tuesday’s bond market moves is that “U.S. bonds outperformed the rest of the world”.
The reason the United States the bond market had sold off on Friday was because the global bond market was “crackling”, according to Hatfield. Germany printed a 5.3% month-over-month gain in producer prices and an “unimaginable” year-over-year gain of more than 30%, while natural gas prices in some regions in Europe reached the energy equivalent of $500 a barrel, fueling fears that the European Central Bank may be “more aggressive”.
But as of Tuesday, a 3% level on the U.S. 10-year yield was attracting interest from buyers and sellers, and remained “pretty entrenched,” Hatfield said by phone, adding that he expects what the Fed raises rates by 50 base. points in September.
“You can’t look at US rates in a vacuum and US bonds are by far the most attractive in the world,” he said. Meanwhile, a short-term Treasury yield that trades above longer-term rates is “pricing stagflation.”