Rates traders should prepare for turbulence around this week’s Federal Reserve decision: Markets aren’t giving up on rate cuts without a fight.
Avoiding a volatile session Wednesday could require some fancy policy-making footwork. There’s a widespread desire for proof the Fed is ready to act, but too much change could raise alarm. Central bankers can adjust their message in a variety of ways, but none of them are likely to produce significantly higher yields, according to investors including Loomis Sayles & Co.’s Elaine Stokes.
The market’s doves have the Fed cornered. If it sticks to its May pledge to be “patient” as it judges future rate moves and keeps the door open to a hike next year, riskier assets like stocks will probably slide and yields will sink further as traders rush to havens.
“The market riots on that,” said Stokes, a fixed-income portfolio manager.
Instead, the Fed is expected to take another dovish turn, just as it’s done all year as weak inflation, deteriorating growth and U.S. trade policy uncertainty sent Treasury yields tumbling. But the Fed hasn’t caught up with rate-cut expectations and probably won’t now, with positioning as aggressive as ever. Anxiety over the Group-of-20 meeting this month has mired the yield on two-year notes around 1.85% -- down from almost 3% in November -- and spurred bets that the Fed policy rate will drop 65 basis points by year-end.
Here’s what to look for in the Fed’s statements and press conference Wednesday and some potential scenarios for reactions in the $16 trillion Treasuries market.
Delicate Balance
Investors are anticipating some combination of the following to demonstrate the Fed’s readiness to cut:
Dropped reference to policy patience and inflation being dragged down by transient factors
Emphasis on weak inflation and growth risks from trade hostilities
Ending the balance-sheet unwind sooner than September
Downward revisions of the rate-projection dot plot
The right balance of these could nudge yields a bit higher, as traders exit some rate-cut hedges. Amherst Pierpont Securities LLC’s head of Treasury trading, Paul Murphy, expects weakening in the two-year note and related futures contracts. But if the Fed convinces investors it’s ready to cut rates, wagers for a move in the third quarter won’t go away.