Feb 1, 2023
Bonds Hear Dovish Message in Powell’s Comments on Disinflation
(Bloomberg) -- Treasuries rallied Wednesday, with most yields falling at least 10 basis points, as investors ran with the view that economic conditions are likely to keep the Federal Reserve from delivering on the additional rate increases policy makers still anticipate.
Yields reached their lows of the day shortly after Fed Chair Jerome Powell began his press conference confirming that the disinflation process had started. Earlier the central bank announced its eighth consecutive rate increase, to a range of 4.5% to 4.75%, and committed to more rate hikes. Still, bond market-watchers characterized Powell’s overall message as dovish even as he reiterated that the policy rate probably will need to rise further to bring about lower inflation.
Initially after the rate increase was announced, yields edged higher led by short maturities, which are most sensitive to changes in the Fed’s target. The two-year notes climbed more than five basis points to 4.25%, the day’s high. It ended the day at 4.11%, down nine basis points, as traders added to bets that the central bank will cut rates by year-end, an outcome Powell said is inconsistent with the Fed’s economic forecast.
“The end is in sight,” said Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investments. “When the markets see that, they think about what comes next, which is a cut. There’s no way around it.”
Powell acknowledged that the “disinflation process has started,” which spurred gains by casting doubt on how long the central bank can keep rates elevated.
The drop in two-year note yields corresponded to a dovish repricing of swap contracts indicating the anticipated path of Fed policy. While the expected peak declined only slightly to about 4.90% for the June contract, the December contract fell 8 basis points to 4.40%, pricing in rate cuts totaling half a percentage point in the interim.
The rally gained steam when Powell discussed policy makers’ 5.1% median forecast for the peak rate this year, made at their December meeting.
“He was specifically asked if the December dots were valid and he didn’t say yes, so one month of data might be changing the Fed’s mind,” said Priya Misra, global head of rates strategy at TD Securities.
“He is committed to at most two hikes, and then the Fed is out,” said Gang Hu, managing partner at Winshore Capital Partners LP, which specializes in inflation-protected investments, citing Powell’s comments suggesting he’s not bothered by easier financial conditions. In that environment “cash comes in and everything goes up.”
The Treasury market rally looked excessive to some investors.
“The bond market has extrapolated Chair Powell’s more balanced tone to think there is a pause coming soon,” said Roger Hallam, global head of rates at Vanguard Group Inc. “That is not what he said today, with at least a couple more hikes to come,” and “he did raise the prospect of doing more if the data was stronger.”
If January employment data to be released Friday is strong, it will “throw into doubt the Fed pausing in the near term,” Hallam said.
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