A report on job growth in May that disappointed some traders sparked an explosion of short covers on Friday. But that has left untouched speculation that the U.S. recovery from the pandemic is strong enough to cause the Federal Reserve to finally start talks this month around the idea of scaling back its massive bond-buying program.
No political decision is expected at the Fed’s June 15-16 meeting. The options market is merging around real change – with the potential to explode returns on their volatility-killing range trade – in August. This is when the Fed traditionally holds its annual meeting in Jackson Hole, Wyoming, which has served as a venue in the past for important political signals.
“The Fed will at least admit that it has gone from abstinence to talking about it,” said Gene Tannuzzo, portfolio manager at Columbia Threadneedle.
“Our timeline for an announcement would center on Jackson Hole as a forum to initiate an academic discussion on the topic,” and September as the baseline scenario to unveil a plan to reduce bond purchases, setting the yield at 10 years for a likely rise to 2% by the end of the year, he said.
Forerunner of hiking
Tapering is important for financial markets because the Fed has signaled that it will be a precursor to real rate hikes. While policymakers expect they will keep overnight rates close to zero until at least 2023, bond traders have been betting for months that the take-off will come early in the year.
With investors holding firm on these expectations for now, volatility has collapsed. A measure of future fluctuations in treasury bill prices is at its lowest since February. And 10-year yields moved sideways, pivoting around 1.6% for weeks, after hitting an over-year high of 1.77% in March.
Preparing for the Fed’s June 16 decision is not without risk. Next week, a report is expected to show that consumer prices accelerated in May at the fastest pace since 2008. This was after the above-forecast reading in April pushed yields towards the higher end of their recent range. There is also a series of $ 120 billion note and bond auctions to be absorbed next week.
Jeffrey Rosenberg, senior portfolio manager at BlackRock Inc., also saw in May’s jobs report – which included strong wage growth – leaving the Fed on track to send a signal in June of a slow movement towards a reduction in asset purchases.
In search of progress
The Fed currently buys about $ 120 billion in debt each month – $ 80 billion in treasury bills and $ 40 billion in mortgage-backed securities. The central bank has said it will continue to do so until it has made “further substantial progress” towards its employment and price targets.
Further on, bets on a Jackson Hole reshuffle have surfaced in the options market, targeting a more aggressive rate outlook for the Fed.
“Until the Fed talks about phasing out, or if we get the wrong inflation number, current yield levels will remain unchanged for now,” said Gary Pollack, head of fixed income for management. of private assets at Deutsche Bank. “But I expect yields to be higher by the end of the year, with 10-year yields rising to 2%. The outlook is still bright for the US economy.