Analysis: With the expected Fed cut, investors brace for rate hikes on the horizon

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A man walks past the New York Stock Exchange at the corner of Wall and Broad streets in New York, New York, United States, March 13, 2020. REUTERS / Lucas Jackson / File Photo

Nov 2 (Reuters) – As the US Federal Reserve prepares to cut back on massive asset purchases, investors reeling from bond market swings are scanning the road for signs of the bank’s effectiveness Central may tighten policy to cope with stubbornly high inflation.

At their meeting this week, Fed policymakers are expected to give the green light to curtailing the central bank’s bond purchases, which have seen it suck $ 120 billion a month in government guaranteed bonds into the aim to stabilize the economy after the pandemic hit.

Reuters Charts

The move, which is expected to begin in mid-November or mid-December, has been widely telegraphed. Still, the Treasury market has stirred over the past week, as investors position themselves for a tighter policy. Investors sharply increased expectations that inflation would force the Fed to raise rates earlier and faster than expected. Short-term rates rose and the yield curve flattened. Read more

“Once you get past the cut-off point, the next big event is if and when the Fed looks to tighten its positions going forward, and that makes every major economic data point that comes out more important.” said Chuck Tomes, portfolio partner. manager at Manulife Asset Management in Boston. “There could be more volatility events around all of these major economic data points.”

Fluctuations in the bond market have likely already caused losses to some leveraged hedge funds, Bank of America warned in a report. Movements could also reflect the unwinding of investor positions to avoid larger losses, Deutsche Bank said. Read more

Wall Street banks, meanwhile, are stepping up preparations for their downsizing to ensure they are able to handle spikes in market volatility. Read more

There may still be surprises. According to Steve Bartolini, portfolio manager for US Core Bond Strategy at T. Rowe Price, failing to cut at this point could dramatically steepen the US Treasury yield curve, while a faster-than-expected cut program would result in substantial flattening.

The Fed’s communication this time around contrasts with that of 2013, when bond yields rose dramatically during the so-called “tantrum tap” after then Fed chief Ben Bernanke said unexpectedly to lawmakers that the central bank could slow the pace of asset purchases that had held up. markets. Benchmark 10-year US Treasury yields fell from around 2% in May 2013 to around 3% in December. Read more

While the move hasn’t been as extreme so far, the US bond market is on track for its first annual loss since 2013.

Reuters Charts

CONCERNS ABOUT PRICES

Investors are heavily focused on rising inflation and are looking to the Fed meeting to see if President Jerome Powell’s position that the price increase will moderate on its own over time could falter. Read more

“It’s about work, inflation, it’s the consumer that concerns us the most,” said Tom Martin, senior portfolio manager at Globalt Investments in Atlanta, who believes long-term bond yields could drop dramatically. times the announcement of the decline announced as rising. short-term borrowing costs are a drag on growth.

“We are concerned that the central bank may make a policy error and raise rates sooner than it should,” said Martin, who said he was “positioned for interest rates to rise. not for a while and we maintain that positioning. “

Stephen Tally, COO at Leo Wealth, said the risk was that “inflation is not as transient as we have been led to believe” and that “is pushing the Fed further and faster than it is. ‘she does not wish it “.

Inflation expectations soared last week, with 5-year and 10-year break-even inflation rates reaching their highest levels in more than a decade.

“Where it’s going to be riskier is how (Powell) dances with the word transient and puts a definition around that maybe in terms of timing,” said Lon Erickson, portfolio manager at Thornburg Investment. Management.

Sit Investment Associates senior portfolio manager Bryce Doty said he recently tweaked the portfolios with rising inflation in mind.

“I think you still need to be heavily invested in TIPS and anything that offers some protection against inflation,” Doty said.

Powell, whose uncertain Fed chairmanship appointment also played into market movements, places rate hikes in a separate box from decrease, with higher interest rates hinging on a return to full employment and inflation reaching the Fed’s 2% target, while moderately exceeding that level. for a while. Read more

Investors are watching the monthly jobs reports closely, with the October release on Friday.

“After a fairly weak September number, are they basing themselves on that October number before they start to deepen the discussion on rate hikes?” Said Jason England, global bond portfolio manager at Janus Henderson Investors.

Reporting by Karen Pierog and Saqib Iqbal Ahmed; Editing by Megan Davies and Andrea Ricci

Our standards: Thomson Reuters Trust Principles.


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