For the world’s biggest bond market, 2019 is turning into a battleground for bets on the path of U.S. monetary policy.
Investors in recent weeks have moved closer to the Federal Reserve’s projected path of three rate hikes next year -- they’re now pricing in two, following expected increases next week and in December. But some, including at Eagle Asset Management and Vanguard Group Inc., still doubt that inflation will be enough of a threat to warrant as much tightening as policy makers anticipate.
This divide may persist at least until November, when the results of U.S. midterm elections make it easier to gauge the potential economic tailwind from fiscal policy. The resolution of the debate over the course of interest rates could prove to be a slow meeting in the middle of the two camps. But it may also deliver a painful blow to bond bulls or even the Fed’s credibility. Either way, the standoff sets the stage for heightened turbulence in debt markets after one of the most subdued stretches in decades.
“The bond market doesn’t believe in the inflation story,” said James Camp, director of fixed-income at Eagle Asset Management, which oversees about $34 billion. “This sets up for a very interesting 2019.”
Traders ramped up bets on 2019 Fed hikes after labor-market data released Sept. 7 showed wages jumped in August by the most since the end of the recession. But Camp, for one, still isn’t convinced inflation will accelerate, a view that gained traction after unexpectedly tame consumer-price figures last week. He’s holding 10-year Treasuries and sees the Fed pausing in 2019 after two more hikes this year, starting with next week’s decision.
The market has been reluctant to price in the Fed’s projected path since this tightening cycle began in 2015, especially after the central bank fell short on delivering the multiple hikes it projected for 2016, eventually moving only once. The dynamic started to change ahead of the March 2017 tightening, when traders had to scramble to price in a hike in response to Fed signals.
Derivative traders see the funds rate only reaching about 2.8 percent by the end of 2020, whereas in June, the median of Fed officials’ forecast was for 3.4 percent.
New Dynamic
“There’s a view that the Fed has largely converged to the market,” said Jan Hatzius, chief economist at Goldman Sachs Group Inc. “From 2012 to 2016, that was true. The period before that it wasn’t true, and the period since then it hasn’t been true.”
Hatzius is among Wall Street economists predicting the Fed will tighten even faster than policy makers indicate. Goldman Sachs, JPMorgan Chase & Co. and Royal Bank of Canada all forecast four increases in 2019.