The bond market is betting on a “dovish pivot” for the seventh time since the Federal Reserve and other central banks embarked on a tightening cycle, raising the prospect of another false dawn, according to Deutsche Bank macro strategist Henry Allen.
US Treasury yields turned sharply lower and bonds rallied in the wake of last week’s Fed policy meeting, at which US central bank Chair Jerome Powell hinted that the current rate-hike cycle may be near an end. The buoyant mood gained further momentum from signs of a softening US jobs market.
Markets now expect 92 basis points of rate cuts next year, compared with Fed officials’ estimate of a half a point of easing for 2024.
“This is at least the seventh time this cycle that expectations have risen about a dovish central bank pivot,” Allen wrote in a report published Monday. The problem, he continued, is that “expectations of a pivot can actually make one less likely, since it eases financial conditions that central banks then feel the need to tighten again in order to bring down inflation.”
Allen highlighted how “last week saw the biggest weekly decline in the 10-year real yield of 2023 so far,” and said that such shifts in economically sensitive rates, “can unintentionally make rate hikes more likely.” Real yields refer to market rates adjusted for inflation.
Prior to this month, the last time traders bet on a Fed pivot in the recent cycle was in March, when the failure of several US regional banks prompted the market to price in hefty rate cuts starting later this year. At that point, the two-year Treasury yield fell to a 2023 low of 3.55%, and the 10-year to around 3.25% Instead, the Fed created a facility for banks to contain financial turmoil and policymakers proceeded to keep tightening.
Beyond March, Deutsche Bank cited these episodes:
• Late September/early October 2022: Cross-asset selloff, centered on turmoil in the UK
• July 2022: Global recession fears and weaker-than-expected US inflation data
• May 2022: Rising concerns about risks to global growth
• Late February/early March 2022: Russia’s invasion of Ukraine
• November 2021: Emergence of Covid-19 Omicron variant sees traders push back timing of first expected hike
And now? While recent US data “have added to the signals that the economy is looking late-cycle,” Allen wrote, “for now at least, it would still be historically early for a pivot towards rate cuts, particularly since inflation is still well above central bank targets.”
Comments from US central bankers this week have stressed the need for vigilance around inflation, with Fed Governor Michelle Bowman saying further rate increases may be necessary and Fed Bank of Chicago President Austan Goolsbee saying policy makers don’t want to “pre-commit” to decisions on rates.
Deutsche Bank’s Allen did leave the door open to the idea that this time may be different, writing that history “tells us that this pivot can happen suddenly when it does occur,” and “further rises in unemployment or another negative shock could well be the catalyst for that occurring.”
This article was provided by Bloomberg News.
