Bond traders, who once grappled with forecasting how high the Federal Reserve would raise interest rates, now face equal uncertainty on the path downward. At TCW Group Inc., Jamie Patton, co-head of global rates, believes the current market expectations for rate cuts are still too conservative, suggesting shorter-dated Treasuries have room to rally. Conversely, Bob Michele from JPMorgan Asset Management contends that the bond market has already priced in rate cuts too aggressively, advocating for corporate bonds with higher yields over Treasuries.
These contrasting perspectives underscore the complex decisions investors face as the Fed is expected to cut interest rates for the first time since 2020 at its Sept. 18 meeting. This anticipation has already driven bond prices up sharply. The uncertainty is compounded by unexpected economic resiliency, highlighted by the recent Labor Department report showing slower-than-expected job growth but not enough to decisively steer Fed policy bets. Market players are split, with some predicting a modest quarter-point cut and others betting on a larger half-point reduction. Over the longer term, swaps markets foresee rates dipping to around 3% by mid-2025, deemed neutral for economic growth.
Traders have been frequently wrong-footed by Fed actions since the pandemic, initially underestimating rate hikes and then prematurely betting on reversals. This history raises doubts about whether current bond prices have surged too far ahead. The two-year Treasury yield's recent drop to around 3.7%, from above 5% in April, reflects expectations of multiple quarter-point cuts. These lower borrowing costs have benefited corporate bonds and equities, easing financial conditions without Fed intervention. Vanguard’s John Madziyire indicates a cautious short bias on bonds, fearing too aggressive rate cuts could spark inflation anew.
However, inflation seems to be cooling; the Labor Department is expected to report the smallest rise in the consumer price index since 2021. The looming Fed meeting, shrouded by a media blackout, leaves markets guessing. Economists largely anticipate avoiding a recession, with stocks hovering near record highs despite recent wobbles. Yet, skepticism abounds. JPMorgan’s Michele foresees the Fed cutting rates modestly by 75 to 125 basis points, drawing parallels to the mid-1990s when the economy sustained growth despite high rates. Nuveen’s Saira Malik agrees, predicting a slower pace of cuts due to the economy’s resilience, which could see the 10-year yield climbing back towards 4%.
The economic calendar is packed with data releases, from inflation expectations to wholesale inventories, which will be pivotal for market sentiment. With central bank officials in a blackout period ahead of the meeting, and a busy auction schedule, market participants will keenly watch these indicators. This dynamic environment sets the stage for significant market movements as investors navigate the Fed’s next moves and the broader economic landscape.
