Investors are primed for a more aggressive policy stance from the Federal Reserve, setting the stage for an escalation in the selling of Treasury bonds.
With the US central bank expected to raise its overnight interest rate by a quarter-point on Wednesday, scrutiny will focus on Fed chair Janet Yellen’s press conference and policymakers’ projections for official interest rates over the coming years, known as the dot plot.
Treasury bond prices have fallen sharply, driving benchmark yields to multiyear highs ahead of the Fed meeting. The 10-year note yield, a key interest rate across the global economy, has for now resisted rising decisively above 2.60 per cent, a level identified by Bill Gross, the bond manager at Janus as marking the start of a secular bear market. DoubleLine’s Jeffrey Gundlach has pinned that figure at 3 per cent.
Investors are worried that an improving economy will spur a more hawkish policy outlook and that Ms Yellen will discuss details of the central bank’s plans for normalising its $4.5tn balance sheet.
Goldman Sachs economists have pulled forward their forecast of when the Fed will begin to start normalising its balance sheet from mid-2018 to late 2017.
David Hoag, portfolio manager with Capital Group, said further selling of Treasuries would require the Fed surprising “us beyond their current hawkishness’’, such as a signal that the central bank is entertaining four 25 basis point rate rises this year.
The market now handicaps the odds of four rate rises at 25 per cent, up from 12 per cent at the end of January.
A strong US jobs report on Friday reinvigorated debate over the probability of a full percentage point increase in the federal funds rate this year, above expectations Fed policymakers published last year. But the lack of acceleration in wage growth has so far curtailed fears of rapidly higher inflation and a subsequently more hawkish US central bank.
“Right now there is a struggle . . . about whether this will become inflationary or not,” said John Bredemus, a strategist with Allianz Investment Management. “I don’t think this is a turning point but it is one of those data points that did not do anything to dissuade people rates and inflation can move up.”