Financial basis

Treasury yields set 3% threshold as CPI waits for next signal By Bloomberg

© Reuters Treasury yields set 3% threshold as CPI waits for next signal

(Bloomberg) — The fate of the world’s largest bond market hinges largely on a single question: Has U.S. inflation already peaked?

Treasury yields have fallen since last month as traders grapple with whether the Federal Reserve should stick to an aggressive round of interest rate hikes or be given the option to ease if the economy slows enough. to curb the highest inflation in four decades.

Friday’s release of the May consumer price index report could help clarify the outlook, potentially holding the key to whether the benchmark makes another retreat or retests the May high by pushing back the level. psychologically key 3%. It flirted with it on Friday, when the yield rose 8 basis points to 2.98% after the monthly jobs report highlighted the economy’s continued strength.

With wages rising sharply in a tight labor market, swap contracts predict the Fed will raise its target rate by half a percentage point at its June and July meetings with certainty. But there’s still no solid consensus on whether policymakers will maintain that pace at the September meeting or embrace a quarter-point move, a step they can take if they fear of plunging the economy into a recession or if they are convinced that inflation is falling.

“The jury is still out in terms of the inflationary trajectory,” Jeffrey Rosenberg, senior portfolio manager for systematic multi-strategy at BlackRock Inc (NYSE:)., said on Bloomberg Television. “You can’t really stop the Fed from focusing on the number one priority – getting inflation down – until you really start to see that definitely show up. Until that happens, it’s going to be a very difficult period.

This uncertainty ahead of the weekend release adds to other forces promising to keep Treasuries volatile in the days ahead, including potential pressure on liquidity. Also this week, the Treasury will hold its first auction since the Fed decided to stop reinvesting proceeds from some of its maturing debt, another tool it uses to tighten financial conditions.

Treasury yields rose across the board on Friday after the Labor Department reported U.S. businesses hired at a faster than expected pace in May. It also showed average hourly earnings were up 5.2% from a year earlier, down slightly from 5.5% in April, but still well above pre-pandemic levels. . The May CPI figure is expected to show an annual increase of 8.3%, matching the pace in April and down from 8.5% in March.

But there are signs of confidence in the Fed’s ability to get it under control. The tightening of its monetary policy has started to lower inflation expectations as rising yields trickle down to the financial system. This combination has pushed real rates, or those adjusted for the expected rate of inflation, above zero this year from deep negative territory, signaling less accommodative financial conditions.

“The jobs data was more in line with a soft landing story,” said Alan Ruskin, chief international strategist at Deutsche Bank AG (NYSE:). However, the risk is that inflation will remain sticky and lag behind a slowing economy, he said, a “dilemma that policymakers wish to avoid but which seems likely”.

The 10-year breakeven rate, which uses the difference between nominal and Treasury inflation-protected yields as a proxy for expected inflation, fell to around 2.75% from 3.1% in early April.

Kathy Jones, Chief Fixed Income Strategist at Charles Schwab (NYSE:) & Co., which manages more than $7 trillion in total assets, says those expectations should stay in check as long as the Fed continues to deliver on its promise to keep rising consumer prices in check.

Fed speakers are “almost all repeating the same script — that getting inflation down is the first task,” Jones said. “As long as they talk and walk, long-term inflation expectations will remain fairly well anchored.”

She expects half-point hikes in June and July before the Fed begins to scale back its increases, though she says an overall strong CPI report would likely bolster sentiment. speculation of a 50 basis point move in September.

Separately, the upcoming auctions of the week will be the first affected by the Fed’s balance sheet reduction plan. Instead of reinvesting its $15 billion in Treasury debt maturing on June 15 in those auctions, which settle on the same day, the bank will only reinvest about $5.6 billion.

The Fed’s reinvestment purchases are made with what are called auction add-ons, which reduce the amount the Treasury has to borrow from the public. While for now the loss of Fed support won’t force the Treasury to sell more debt as outsized tax revenues have reduced the deficit, strategists predict that the Fed’s reduced hand in the market will hurt liquidity and will increase volatility.

Meanwhile, a possible sale of corporate debt of Oracle Corp. (NYSE:). linked to a $28 billion acquisition could boost volatile hedging activity.

“You have a market that may not be able to withstand some of the run-off that we’re going to have,” said Ira Jersey, chief U.S. interest rate strategist at Bloomberg Intelligence, referring to the cut. of the Fed’s balance sheet. “So you’re going to see significantly higher volatility in the rates markets.”

What to watch

  • Economic calendar:
    • June 7: trade balance; Consumer credit
    • June 8: MBA mortgage applications; wholesale
    • June 9: Unemployment insurance claims; June Bloomberg US Economic Survey; household net worth
    • June 10: consumer prices; real average hourly earnings; Sentiment/Current Conditions/Expectations of University of Michigan; monthly budget statement
  • The Fed’s calendar is empty due to the standard pre-FOMC meeting silence period
  • Auction schedule:
    • June 6: 13 and 26 week invoices
    • June 7: 3-year tickets
    • June 8: reopening of 10-year bonds
    • June 9: 4- and 8-week notes, reopening of 30-year bonds

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