Bond Traders, Spooked by Tumult in Stocks, Doubt Fed's Rate Path


The bond market is losing confidence in the Federal Reserve’s policy tightening projections after a punishing stretch for U.S. stocks.

Traders pared wagers on 2019 rate hikes last week as disappointing corporate earnings helped drag the S&P 500 Index down 10 percent from its record high at one point Friday. Markets are now factoring in fewer than two quarter-point hikes for next year, compared with the three increases that policy makers project. Tanking inflation expectations suggest some investors already deem Fed policy too restrictive.

Should the carnage in equities continue, TD Securities reckons the debate over a December Fed move may intensify. Eurodollar options activity suggests the same, with traders starting to ponder the possibility of a Fed respite at year-end. While TD expects the central bank to proceed with its ninth hike of this cycle, signs that liquidity is getting more scarce could get policy makers’ attention, said Priya Misra, head of global rates strategy.

“I can see another week like last week taking December hike odds down to 50 percent because of the tightening in financial conditions,” Misra said. “Do they want to pause and see if the economy can handle this tightening? That’ll be the question.”

Ten-year Treasuries are coming off their biggest rally since May. Yields sank 12 basis points last week to about 3.08 percent, after setting a seven-year high of 3.26 percent earlier this month.

Risk Ahead

There’s risk ahead for bond bulls in October’s employment report, to be released Friday. Confirmation of labor-market strength or evidence of quickening wage growth could reignite tightening bets. Average hourly earnings likely rose 3.2 percent from a year earlier, according to a Bloomberg survey of economists, up from a 2.8 percent increase in September. It would be the largest acceleration since 2009.

“Something that takes average hourly earnings to cycle highs would be enough for the market to say, ‘This is why the Fed needs to keep hiking,”’ Misra said. “Unless there’s a massive drop in wages, the Fed’s path of least resistance will be to hike.”

So far, Fed officials are still signaling a gradual path of rate increases, and despite the wobble in December hike odds, others still see it as a lock. A continued crunch tighter in financial conditions could eventually merit a Fed pause, but it’s probably too early for that discussion, according to Nomura Securities.

“The December hike -- it would take a lot for them not to hike, so that’s a done deal,” George Goncalves, Nomura’s head of Americas fixed-income strategy, said in a Bloomberg Television interview. “If things get even more turbulent, perhaps they would pause, but that’s really more of a 2019 story.”

What to Watch This Week

  • Friday’s payrolls report is the highlight of U.S. economic data releases
    • Oct. 29: Personal income/spending; Dallas Fed manufacturing
    • Oct. 30: S&P CoreLogic home prices; Conference Board consumer confidence
    • Oct. 31: Weekly mortgage applications; ADP employment; employment cost index; Chicago purchasing managers
    • Nov. 1: Challenger job cuts; nonfarm productivity; jobless claims; Bloomberg consumer comfort; Markit U.S. manufacturing PMI; construction spending; ISM manufacturing
    • Nov. 2: October employment data; trade balance; factory orders/durable goods
  • Treasury’s quarterly refunding announcement on Oct. 31 will be closely watched
  • Fed officials of past and present appear
    • Oct. 29: Chicago Fed President Charles Evans speaks in Chicago
    • Oct. 30: Former Fed Chair Janet Yellen speaks in Washington