(Bloomberg) — The U.S. bond market is teaching us a lesson about the new world investors live in: The data is far more important than anything the Federal Reserve might say.
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That was on full display Wednesday, when a softer-than-expected rise in the consumer price index that morning sparked one of the biggest treasury rallies of the year.
Less than six hours later, after the Fed’s latest economic projections predicted just one rate cut this year, the rally weakened somewhat. But inflation revived on Thursday after an unexpected drop in producer prices and a rise in unemployment claims indicated that inflationary pressures continue to ease. The 10-year yield ended Friday at almost 4.2%, down 21 basis points in the biggest weekly drop since mid-December.
In short, the expansionary inflation numbers drowned out any hawkish noise from the Fed.
The moves underscore the diminished significance of the Fed’s guidance at a time when the economy continues to surprise virtually everyone, including central bank policymakers themselves. Fed Chairman Jerome Powell acknowledged this at last week’s press conference after the meeting, saying the Fed is mindful of going where the data leads.
That means the bond market is likely to continue on a rather bumpy path as interest rate prospects are reassessed as key data arrives.
Policymakers “are going to talk, but the market has to assess what they say more than normal in this environment,” said Jean Boivin, head of the BlackRock Investment Institute. “This environment is one of excessive response to incoming macro data.”
These data points have been more favorable for bond investors lately. The core consumer price index rose less than expected by 0.2% in May, a welcome shift from earlier this year when higher-than-expected data fueled concerns about high inflation. While wage growth remains solid, other data such as vacancies, unemployment benefit claims and unemployment suggest the labor market is cooling.
This data strengthened investor confidence that the Fed will cut rates later this year. Traders estimate the Fed will most likely cut rates by two quarter points this year, with the first step now taking place as early as September, derivatives trading shows.
That’s a bit more aggressive than what Fed officials put forward in their so-called dot-plot forecasts. Their average projection was one cut this year, compared to the three telegraphed at the March meeting. However, officials now see four cuts for 2025, more than the three previously outlined.
But Powell indicated that investors should take these forecasts with a grain of salt, saying Fed officials are not “trying to send a strong signal.”
A data-dependent Fed doesn’t mean that every economic figure will change the policy trajectory, and as volatile as bond prices have been, market expectations are much more in line with the Fed’s than they were at the end of last year. At the time, traders expected a steep series of cuts to take place as early as March.
What strategists say…
The economy appears so robust that the Federal Reserve may not start cutting rates until after the US elections in November, which will keep the yield curve inverted until rate cuts begin. Fed sentiment remains largely neutral, even as the economy is running well above trend and inflation remains above the Fed’s 2% target.
—Ira Jersey and Will Hoffman. Read more here.
Fed officials have said it will take several good inflation reports before they will feel confident enough to ease policy.
“They’re really not going to overreact to one or two data points,” said Gargi Chaudhuri, head of iShares Investment Strategy, Americas at BlackRock Inc.
Without reliable guidance from the Fed, observing data is inherently associated with more volatility. Government bonds staged a strong rally late last year after a sharp fall in inflation, before reversing sharply in the first four months of 2024. Then the market made another reversal, one that pushed the 10-year yield down by almost half a percentage point. since the end of April.
The market is about to take a breather this week as there is no major data to rival the jobs and inflation reports from the past two weeks. A slew of Fed officials, including Governors Lisa Cook and Adriana Kugler, will speak next week, as they often do after policy-setting meetings.
“The markets are currently, sort of overreacting, to a single set of discrete data points,” said Jerome Schneider, head of short-term portfolio management and financing at Pacific Investment Management Co. “These positive signals are only now starting to break through. sunrise, although the longer-term situation is still a bit cloudy.”
What to watch
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Economic data:
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June 17: Empire production
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June 18: NY Fed Business Activities; retail; industrial production; capacity utilization; production (SIC) production; business inventory, TIC flows
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June 19: MBA Mortgage Applications; NAHB housing market index
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June 20: current account balance; initial unemployment claims; housing/building permits; Philadelphia Fed Business Outlook
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June 21: S&P Global manufacturing, service PMI (preliminary); Leading index; existing home sales
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Fed Calendar:
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June 17: Philadelphia Fed President Patrick Harker; Fed Governor Lisa Cook
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June 18: Thomas Barkin, president of the Richmond Fed; Boston Fed President Susan Collins; Dallas Fed President Lorie Logan; Federal Reserve Governor Adriana Kugler; St. Louis Fed President Alberto Musalem; Chicago Fed President Austan Goolsbee
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June 20: Minneapolis Fed President Neel Kashkari; Barkin of the Richmond Fed
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Auction calendar:
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June 17: 13 and 26 week bills; 42-day cash management accounts
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June 18: Reopening of 20-year bonds
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June 20: 4, 8, 17 week bills; five-year TIPS reopening
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—With help from Cameron Crise.
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