The bond market is bracing for a quiet end to a tumultuous year, with hopes pinned on a further Federal Reserve interest rate cut. However, a surprise inflation spike could disrupt this anticipated calm.
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Treasuries rallied on Friday following the November jobs report, which signaled a cooling labor market, bolstering expectations for another Fed rate cut at its December 18th meeting. This jobs data, along with this week’s consumer and producer price index reports, are considered crucial indicators before the Fed’s decision. Current expectations point to minimal inflationary pressure increases.
“Barring a significant upside surprise in CPI, the Fed is likely to cut rates this month, believing their policy remains restrictive,” notes Gang Hu, managing partner at Winshore Capital Partners. “This suggests Treasury yields may have peaked.”
Riding the Wave of Rate Cut Expectations
This prevailing sentiment offers investors respite from the November bond market sell-off triggered by concerns that then President-elect Trump’s trade and tax policies could reignite inflation. Since then, yields have retreated on speculation of a further Fed easing at its December meeting, the last before Trump’s inauguration, as the central bank aims for a soft economic landing.
The benchmark 10-year Treasury yield has fallen to approximately 4.15% from its post-election peak of 4.5% on November 15th. This decline contributed to a 2.4% return for Treasuries year-to-date through December 5th, according to a Bloomberg index.
Looming Uncertainty Clouds the Horizon
Despite the current calm, significant uncertainty persists due to potential policy shifts under the new administration. Trump’s proposed tax cuts could inject stimulus into an already robust economy, potentially accelerating bond sales and widening the deficit. His trade policies also present a wildcard, possibly raising import prices and impacting global trade.
These uncertainties could cap bond market gains as traders and Fed policymakers adopt a cautious wait-and-see stance. Swaps pricing suggests a potential pause in rate cuts at the January meeting.
“The US economy demonstrates remarkable resilience,” observes Tracy Chen, a portfolio manager at Brandywine Global Investment Management. “The Fed is likely nearing a pause in its rate-cutting cycle, potentially early next year, to reassess in light of Trump’s policies and incoming data.”
Inflation Remains a Key Variable
Bloomberg Economics’ nowcast projects a 0.2% month-on-month increase in headline inflation for November, translating to a 2.6% year-on-year rate, mirroring October’s figures. This suggests persistent inflation, potentially prompting the Fed to exercise caution regarding a December rate cut.
Friday’s employment data reinforced the view that the Fed’s restrictive policy is cooling the economy. While hiring recovered in November from the previous month’s hurricane-induced slowdown, the unemployment rate unexpectedly ticked upwards. This data likely provides the Fed with leeway for easing this month, unless inflation data reveals an unforeseen surge. The consensus forecast anticipates a 0.3% rise in core consumer prices, a key indicator of underlying inflation.
“All signs point to a December rate cut, but inflation remains a critical factor, introducing a degree of tail risk surrounding the CPI release,” says Amar Reganti, fixed-income strategist at Hartford Funds.
He adds, “However, given the recent decline in Treasury yields, further significant drops seem unlikely unless inflation softens considerably. This is particularly true given the uncertainties surrounding future executive and congressional policies.”
Navigating the Road Ahead
The bond market’s trajectory hinges on upcoming economic data, including wholesale inventories, consumer and producer price indices, and jobless claims. Market participants will also closely monitor developments in the Fed’s communication blackout period preceding its policy meeting and scheduled Treasury auctions. These factors will collectively shape the bond market’s course in the final weeks of 2024. Navigating this landscape requires vigilance and adaptability to potential shifts in the economic and political environment.
