How a Fed pause may — or may not — affect bonds
Federal Reserve Board Chair Jerome Powell made it clear the Fed expects to keep rates at a range of 1.50% to 1.75% unless events result in a “material reassessment” of the Fed’s outlook.
"While the rate cut certainly means that yields on treasuries are headed lower, it may not be so for the rest of the bond market,” said Zach Abraham, principal/CIO at Bulwark Capital Management. “At some point in this cycle we will see spreads blow out. It's inevitable, as it occurs in every cycle. Flight to safety puts a bid under treasuries while corporates are shunned as weakening economic fundamentals raise risks, or at least perceived risks, of corporate defaults.”
He called Powell’s claim that the Fed is on pause “a bit humorous.” The Fed trimmed the rate target by 75 basis points in the past three meetings and “launched a $100 billion standing repo facility (just quantitative easing by another name). It's time we all face the facts. The Fed has a tiger by the tail and has no clue how to let go,” Abraham said. “Investors, as well as the market, are beginning to figure this out. Barring some exogenous/inflationary shock, we're headed back to the zero bound"
If rates remain steady, it “will keep an underlying bid in the bond market for some time,” according to Marty Mitchell of The Mitchell Market Report. “It should also embolden equity investors to keep employing capital in the market.”
With Powell declaring a pause, and setting a high bar for rate hikes, it should cut down on volatility, with individual monthly numbers meaning less. “This effectively removes the prognostication, uncertainty, and handicapping that goes on between FOMC meetings.”
Despite Powell’s assertions, not everyone believes rates are on hold for long.
The odds are the Fed will watch whether the U.S. consumer will continue to fuel the economy, said Sebastien Galy, senior macro strategist at Nordea Asset Management. “It is likely just a matter of time before the Fed cuts again.
“The faster it eases the faster the economy rebounds or it simply can wait it out for a few months and do the same.”
With purchasing managers' indexes suggesting “stagnant growth ahead” and inflation short of the Fed’s 2% target, Keefe, Bruyette & Wood Director of Research Fred Cannon expects further easing. KBW’s baseline expects two more rate cuts and bond yields “dipping meaningfully.”
“Financial markets remain convinced more rate cuts are coming for a few reasons,” said Edward Moya, senior market analyst, New York at OANDA. “The Fed has compared this mid-cycle adjustment to the prior two in 1995 and 1998,” but in those cases the labor market was stronger and “economic growth was significantly higher than what the U.S. is currently experiencing.”
Additionally, “giant macro risks from the trade war and Brexit will continue to cloud the economic outlook well into 2020,” Moya said. “Lastly, economic data has been trending lower and while the consumer remains strong, we are starting to see some red flags in the credit markets.”
This “hawkish cut,” he said, “has pretty much locked the Fed into keeping the rates on hold in December and possibly into the spring, despite huge geopolitical risks from the trade war and Brexit. A lot could go wrong in a moment’s notice and this may go down as huge policy mistake.”
The Chicago Business Barometer fell to 43.2 in October, its lowest read since December 2015, and its second consecutive contractionary level, after posting a 47.1 in September. “The survey points to further weakness in business activity, with the three-month average falling further to 46.9,” according to a release.
Economists polled by IFR Markets expected a 48.0 read.
Meanwhile, personal spending rose 0.2% in September, matching August’s gain and projections, while income grew 0.3% after a 0.5% jump a month earlier, also matching projections.
The Commerce Department reported core personal consumption expenditures were flat in September and up 1.7% year-over-year.
The Employment Cost Index jumped 0.7% in the third quarter after a 0.6% gain a quarter earlier, the Labor department reported. The gain matched expectations.
Initial jobless claims rose to 218,000 in the week ended Oct. 26 from 213,000 the week before, while continued claims climbed to 1.69 million in the week ended Oct. 19, up from 1.683 million the week before, Labor said. Economists expected 215,000 initial and 1.683 million continued claims.